A Quarterly Market Review in 6 Charts: Third Quarter 2020

The U.S. economy made up ground in the third quarter that was lost in the first half of the year courtesy of the coronavirus pandemic, with businesses reopening and production resuming that was previously halted. Gross domestic product grew 7.4% in the third quarter, equivalent to an annual rate of 33.1%. This is in stark contrast to the second quarter, where it dropped at a record pace of 9%, or 31.4% at an annual rate.

U.S. stocks continued their upward trend from the second quarter, with an 8.9% quarterly gain. However, stocks slid in September over caution of increasing virus case numbers in the United States and Europe without the prospect of a vaccine soon. This was in addition to pending election uncertainty surrounding taxes, healthcare, and foreign relations. Investors have tried to profit off the increased market volatility, although not successfully.

Additionally, consumer spending took off in the third quarter, digging the economy further out of the hole created by the pandemic. This is likely a trend that will continue into the holiday season.

Every quarter, Morningstar's quantitative research team reviews the most recent U.S. market trends and evaluates the performance of individual asset classes. We then share our findings in the Morningstar Markets Observer, a publication that draws on careful research and market insights. (Morningstar Direct and Office clients can download the report here.)

Here are some of the findings from our latest quarterly market review.

U.S. Economy Posts Sharp Rebound in the Third Quarter but Remains Below 2019 Peak U.S. GDP grew at a 33.1% annualized pace in the third quarter, bringing the "size" of the U.S. economy to about 3.5% below its peak at the end of 2019, in real terms. For context, following the global financial crisis, it took the U.S. economy around three years to return to its pre-recession peak. Residential investment was particularly strong in the third quarter, but nonresidential (business) fixed investment remained about 5% off from its end-2019 level.

Source: Bureau of Economic Analysis, Federal Reserve Bank of Atlanta. Data as of October 29, 2020.

A New Downturn, a New Recession, and a New Recovery, All in 2020 U.S. stocks dropped 19.6% during the first quarter's coronavirus-driven bear market, calculated using monthly returns. Using daily returns, the loss was 33.8% (from the Feb. 19 peak to the March 23 trough). The market fully recovered these losses by July, marking the beginning of a new expansion only four months after the end of the downturn. With the constant threat of coronavirus still looming, it is too early to know whether the new expansion is here to stay.

Source: Stocks—Ibbotson Associates SBBI U.S. Large Stock Index. Recession data from the National Bureau of Economic Research (NBER). Data as of September 30, 2020.

The American Consumer Is Back! But for How Long? Third-quarter data suggests pent-up consumer demand was stronger than initially expected, as total retail sales blew past pre-pandemic highs. These sales continued to favor online retailers, but brick-and-mortar stores (captured in the "All Other" category), as well as restaurants and bars, helped push the needle higher. It's difficult to imagine these trends persisting amid another surge in cases and the onset of winter; but it's also hard to bet against the American consumer's resilience.

Source: U.S. Census Bureau. Data as of September 30, 2020.

Can the U.S. (Socially) Economically Distance from China? Both the Trump and Biden campaigns have proposed reducing economic ties with China. U.S. bilateral trade flow with China is lower than with other major trade partners, although China's presence is more prominent in terms of advanced technology products. Direct investment by U.S. companies in China and Chinese companies' assets in the U.S. are very small compared with other regions. China is certainly an important economic partner, but it's far from the most important.

Source: Bureau of Economic Analysis, Census Bureau. Data as of September 30, 2020.

Global Search for Yield Finds Few Opportunities in Developed Sovereign Bond Markets The U.S. was the only major developed economy to see longer-term government-bond yields rise in the third quarter. Even then, yields remain near historic lows. European yields ended the quarter lower as economic indicators pointed to a slower-than-expected recovery. In the United Kingdom, gilt yields started showing signs of following U.S. yields higher, but Brexit pressure added to the uncertainty of an already-tenuous economic recovery.

Source: Macrobond. Data as of September 30, 2020.

A Tale as Old as Time: Investors Are Bad at Market-Timing Given the market downturn in March, it is surprising to see that the month's net flows into leveraged equity funds reached $5 billion, the highest they have been in two years. Conversely, when the market bounced back in April, investors switched gears and sought exposure to inverse equity funds, perhaps anticipating that a quick rebound wasn't sustainable. As time passed, they slowly gave up this plan as well. The ups and downs in the chart below illustrate the formidable challenge of timing the market.

Source: Morningstar Direct. Data as of September 30, 2020.

This article is adapted from research that was originally published in Morningstar Direct’s Research Portal. If you’re a user, you have access. If not, take a free trial.