The third quarter saw muted returns after the economic reopening story, and accommodative government policies helped drive strong returns in the first half of the year. The quarter got off to a strong start, but continued concerns about persistent inflation, supply chain disruptions, and potential fiscal policy changes caused a turbulent September that wiped away gains made in July and August.
Near the end of September, Evergrande, one of the largest property developers in China, announced it may default on upcoming loan payments[i]. This announcement led to concerns about potential contagion effects, and markets turned downwards. Shortly thereafter, the Fed indicated that tapering of bond purchases could begin this year and rate hikes may begin in 2022[ii], earlier than had been previously predicted. On Tuesday September 28th, the yield on the 10-year Treasury climbed as high as 1.567%, after being as low as 1.13% the month before. Stocks fell sharply, with the NASDAQ (-2.8%) posting its worst day since March, 2021[iii].
Notwithstanding all the negative headlines in September, all major stock indices, except for emerging markets, are still strongly positive for the year.
Large cap stocks outperformed small caps in the third quarter. Larger companies may have the resources to be more resilient and tend to fare better in an uncertain economic backdrop. However, when economic growth is expected to accelerate, small cap tends to outperform, as we saw in the first half of the year.
International developed markets were down slightly for the quarter but still boast a strong return for the year. Emerging markets countries fell the most, fueled in part by the spreading Delta variant and by regulatory actions taken by China, particularly in the technology sector.[iv] Chinese stocks make up roughly a third of the emerging markets index.
In the US, value stocks outperformed growth in small cap, but the opposite was true in large cap, where growth outperformance was fueled by the big tech names that may be better positioned to operate in a pandemic environment.
In fixed income markets, US investment grade bonds were challenged by rising yields but ultimately ended the quarter relatively flat. Municipal bonds, in part because of supply/demand dynamics, were flat for the quarter but remain positive for the year. High yield bonds did the best out of all bond indices covered, aided by investors that are hard pressed to find better yield opportunities elsewhere. Locally denominated emerging markets bonds fell just over 3% in the quarter, hindered by a strengthening US dollar.
After markets enjoyed a generally positive July and August, a poor September brought returns for most equity indices down for the quarter. However, in most cases this was not enough to overshadow the strong returns experienced in the first half of the year. While market volatility may make investors feel uneasy, it is good to remember that market pullbacks are normal, with the S&P 500 generally seeing a 5% pullback 3-4 times a year on average[v]. In most cases, tuning out these short-term concerns and employing patience and discipline when investing is the best way to respond to any rough patch in the markets.
[i] Michelle Toh, “5 things to know about the Evergrande crisis: A simple breakdown, CNN.
[ii] Jeff Cox, “Federal Reserve holds interest rates steady, says tapering of bond buying coming ‘soon’”, CNBC.
[iii] Jesse Pound, “Nasdaq tanks 2.8% in worst day since March as yield spike hits tech stocks, Dow drops 570 points”, CNBC.
[iv] Billy Perrigo, “Here’s What to Know About China’s Sweeping Tech Crackdown—and Why It Could Make U.S. Big Tech Regulation More Likely”, Time.
[v] Eric Rosenbaum, “Dow, S&P 500 fears? Why worrying about a correction is still the wrong way to invest”, CNBC.
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Dow Jones Industrial Average Index: measures the performance of 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.
Russell 3000 Index (U.S. Stock Market): measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. These securities are traded on the NYSE, NYSE MKT, and NASDAQ.
S&P 500 Index (Large Cap U.S. Stocks): measures the performance of large capitalization U.S. Stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, NYSE MKT, and NASDAQ. The weightings make each company’s influence on the Index performance directly proportional to that company’s market value.
Russell 2000 Index (Small Cap U.S. Stocks): An unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
MSCI EAFE Index (International Developed Stocks): The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
MSCI Emerging Markets Index (Emerging Markets Stocks): is a Morgan Stanley Capital International Index that is designed to measure the performance of equity markets in 23 emerging countries around the world.
Bloomberg Barclays US Aggregate Bond Index (U.S. Bond Market or Investment Grade U.S. Bonds): includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.
Bloomberg Barclays Muni Bond Index 1-10 Yr Blend (1-12) (Int-Term Municipal Bonds or US Municipal Bonds): A market value-weighted index which covers the short and intermediate components of the Barclays Capital Municipal Bond Index. The 1-10 Year Municipal Blend index tracks tax-exempt municipal General Obligation, Revenue, Insured, and Prerefunded bonds with a minimum $5 million par amount outstanding, issued as part of a transaction of at least $50 million, and with a remaining maturity from 1 up to (but not including) 12 years.
ICE BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index (High Yield U.S. Bonds): Tracks the performance of US dollar-denominated below-investment-grade (BBB rated) corporate debt publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis.
JPM GBI EM GD USD Unhedged Index (Emerging Markets Bonds): The JP Morgan EMBI Global Diversified is a uniquely weighted index that tracks total returns for U.S. dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The index limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding.
JPM EMBI GD Index: J.P. Morgan Emerging Markets Bond Global Diversified Index (EMBI Global Diversified) tracks the returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi- sovereign entities: Brady bonds, loans, Eurobonds. The index limits the exposure of some of the larger countries.