Market Update: December 8, 2020

It’s hard to find enough superlatives to describe November’s equity market performance.

• It was the best month EVER for the benchmark MSCI ACWI Index (dating back to its inception in 1988), in a testament to the breadth of the market.
• It was the best November for the S&P 500 since 1928 and the 24th best month over the entire 92 years of S&P data (98th percentile event, or about a 2.3 standard deviation from the norm).
• It was the second-best month since 1979 for the EAFE index (Europe, Australasia and the Far East), and just 10bp from becoming the best.
• It was the best month since March 2016 for Emerging Markets.

We could go on, but the point is clear: this was a historical month in equity markets. Novembers of election years tend to be strong, but this one was truly exceptional even by those high standards.

Besides putting most of the election uncertainty behind us, optimism about impending coronavirus vaccines also drove strong fund flows into stocks. Fund flows reflected not just a rotation within stocks, but also flows out of bonds as interest rates rose globally, though they remain below pre-coronavirus levels.

A more detailed look at November’s astounding performance

The U.S. market’s strength was pervasive across almost all sectors; the single exception was utilities, which went up but only by a modest 0.26%. Oil made a significant move in November: WTI crude crossed back above the $40 per barrel level based on optimism that with a vaccine in sight, some of the demand that coronavirus destroyed might soon return. This hopefulness served to make energy the strongest sector by far, up 28% for the month.

U.S. Large Cap Value outperformed U.S. Large Cap Growth in November. Importantly, the strength in Value of late has not come at the expense of Growth, which is yet another sign of how broad the participation has become in this market. Historically, large rotations have come where one asset class is gaining at the expense of the other, and we are not seeing that right now. That does not preclude a potential rotation in the near future, to be sure, but at the moment it does not appear to be happening. But even as Growth stocks continue to do well, the breadth of solid performance – within the U.S. and internationally – continues to buoy the narrative that it is not just the FANMAG stocks (i.e., Facebook, Apple, Netflix, Microsoft, Amazon, and Google) driving the market, which was the concern for quite some time.

The U.S. dollar returned to its recent weakness after stabilizing for a few months, serving as a tailwind for commodities and international assets. Within the commodity space, precious metals have taken a breather from their parabolic ascent into August, which culminated in gold breaching $2000. Meanwhile soft commodities and industrial metals have outperformed precious metals of late, though precious metals continue solid uptrends despite the underperformance relative to equities in November. This is subject to change, of course, but we must note that underperformance on a relative basis does not equate with weakness in longer-term absolute trend.

• Highlighting the breadth of the international stock strength, November proved to be one of the top five months ever for over a quarter of the countries in the MSCI ACWI Index, and one of the top ten months ever for half the index.

Our team had begun to pick up signs that this kind of upswing was coming, and as a result, we increased our position in Emerging Markets in November. While EAFE is not quite there in terms of an increased allocation, it is not as far off the radar now as it was a few months ago. We will continue to monitor the progress of these markets.

After seeing much strength at the outset and early on in the pandemic, fixed income returns have been relatively flat the last few months. We are starting to see rates tick up across the globe as markets begin to price in a global synchronized recovery. It’s not just that they’re going up; rates are moving higher in the right magnitudes to steepen global yield curves, which has historically been a bullish development. And as rates are moving higher, we are seeing the largest shift in fund flows from bonds to stocks since the onset of the pandemic, which is likely to serve as a further tailwind for equity markets.

Credit spreads continue to narrow, both in high-yield and investment grade bonds. In fact, many are at lows not seen since the peak in spreads in late March, which makes this movement particularly notable.

Taking the bigger view

What does it all mean, taken together? Here’s how we see the big picture.

Markets are in a solid sweet spot right now. Momentum is strong and stocks are not expensive at the current level of interest rates, given the ongoing earnings recovery and the steepening of the yield curve.

The breadth we are seeing in markets is worth repeating; global equity markets have not been this broad since 2013. All 50 of the markets in the MSCI ACWI Index are above both their 50-day and 200-day moving averages. Since 1988, this has happened only a handful of times: a) January 1994, b) January 2004, c) February 2005, d) August 2009, and e) now. The first four periods were relatively early in global bull markets, hence our thesis that we are looking more like early cycle rather than late cycle after the coronavirus market crash and rebound.

The strength in November and early December has been historically anomalous. Markets will need to take a breather from the hot sentiment at some point. The biggest threat to any market rally is generally excessive optimism, and this time will probably be no different. Given the strong seasonal effects in December, the brief corrective action we anticipate is likely a Q1, 2021 phenomenon but timing is uncertain, as always. Regardless of whether such a correction and/or consolidation occurs in December or in the first quarter of next year, it is highly likely to happen simply because the markets need a pause that refreshes before moving higher.

There are numerous signs that markets are focusing on life after the pandemic. Even in the face of new coronavirus lockdowns throughout the world and the sharp increase in new cases, both in the U.S. and globally, we’ve seen many signals that the markets are looking ahead to a post-pandemic world. Interest rates have consistently been moving higher for the last four months, albeit slowly, and many of the “stay at home” stocks that thrived so strongly during the heart of the pandemic have begun to lag parts of the market most affected by coronavirus (e.g., airlines, banks, travel and hospitality, casinos, retailers, real estate). For example, we have seen recent outperformance of:

• Live Nation over Netflix (go out or stay home?)
• Macy’s over Amazon (shop brick and mortar or shop online?)
• Planet Fitness over Peloton (work out at the gym or work out at home?)
• Delta over Zoom (live meeting or virtual meeting?)

While some of these results stem merely from reversion to the mean, it is likely that the re-opening trade still has room to run given how far many of those stocks most affected by coronavirus fell and how relatively little they have clawed back so far. The re-opening stocks don’t necessarily have to go up at the expense of leading stocks; there is no reason to suggest that both the laggards and the leaders cannot move up together in a strong market with the breadth that we are seeing.

With people and markets both by all indications appearing to focus increasingly on what comes when we’re finally past this pandemic, there’s a glimmering light at the end of the tunnel. We simply have to avoid getting ahead of ourselves, stay vigilant and try to contain our exuberance until we emerge safely on the other side.