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U.S. Equity Funds Rebound in the Second Quarter

U.S. stocks have pulled off an astounding recovery.

Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Following the first quarter's market plunge from all-time highs, the U.S. stock market rebounded in the second quarter on the hopes of a return to normalcy. After falling more than 34% peak to trough in 2020's first quarter, the Morningstar US Market Index bounced back 19.8% in the second quarter and was down just 5.1% for the year through June 24. The second quarter's surprising recovery is a reminder that the economy and markets don't always move in tandem. Large numbers of coronavirus cases, struggling small businesses, civil unrest, and the highest rates of unemployment since the Great Depression plagued the nation--yet, U.S. stocks continued to rise.

The market's second-quarter comeback implies a very optimistic outlook. On the whole, stock prices are baking in a return to normal, but a lot remains uncertain. Stay-at-home orders began to lift in the latter half of the quarter, but success in reopening the economy hinges upon keeping infection rates limited. Healthcare firms pressed on with progress toward a coronavirus vaccine, but estimates of when one will be publicly available still vary. Vaccine development will be an important catalyst in removing social distancing measures and ultimately reigniting economic growth.

All 11 Morningstar sectors had positive returns from the start of the second quarter through June 24. Consumer cyclical names led the pack as increased retail spending resulted from eased lockdown restrictions. Names such as Wayfair W, Etsy ETSY, and eBay EBAY bounced back sharply from the previous quarter's market bottom and posted strong year-to-date gains. Technology names continued to win in the second quarter, bolstered by software firms; DocuSign DOCU, Coupa Software COUP, and Square SQ surged forward as their technologies became increasingly valuable during a period of heightened remote work. Energy's strong performance didn't make up for its first-quarter losses. The sector fell 51.2% in the first quarter as Saudi Arabia and Russia undercut each other with oil production and pricing decisions while travel came to a halt. Though energy names on balance grew 29.9% in the second quarter as the price of West Texas Intermediate crude-oil began to claw its way back toward previrus levels, the sector still carried a 36.7% loss for the year-to-date period through June 24.

All areas of the Morningstar Style Box rose in the second quarter, but in general, growth continued to outpace value. The stark performance contrast between growth and value that has persisted for several years lived on in the first half of 2020. Growth names were up 13.1% for the year to date through June 24, while value names ended that period down 20.0%. Small caps beat large caps for the quarter-to-date period but lagged by 6.4 percentage points for the year through June 24. U.S. equities also maintained their lead over international equities in the second quarter.

Winners Some value strategies that took large hits in the first quarter were subsequently top performers in the second. Dodge & Cox Stock DODGX was one of them. The contrarian strategy, which has a Morningstar Analyst Rating of Gold, fell almost 40% peak to trough in the 2020 drawdown and trailed nearly three fourths of large-value peers in the first quarter. The strategy bounced back with a top-decile performance relative to peers in the second quarter, though, led by strong energy and communication-services picks. The fund's growthier names such as Alphabet GOOG and Microsoft MSFT helped, too. Bronze-rated Hotchkis & Wiley Mid-Cap Value HWMIX also saw a large swing in the second quarter. The strategy sported top-percentile returns in its mid-value Morningstar Category for the quarter through June 24, yet its first-quarter drop was so severe it still lagged 99% of peers for the year to date. Its stunning 55.5% fall during the first-quarter plunge was in large part due to is sizable energy stake--the same active weighting that led to its peer-topping second-quarter performance. The strategy has long had down-market volatility and requires a long-term mindset.

Many growth strategies showed resilience throughout the quarter and prior. A growth tailwind and stellar healthcare and technology picks led Alger Small Cap Focus AGOZX to outpace 95% of small-growth peers for the year to date. The Silver-rated fund was up 17.1% since the start of the year through June 24 versus its typical peer's 2.8% loss. Healthcare firm Quidel QDEL bolstered returns over that time as the company found success in a COVID-19 antibody test. Everbridge EVBG, an emergency communications software company, also contributed to the fund's strong returns as of late. The strategy's performance in 2020 is not an outlier--its returns landed in the top quintile of peers over the trailing one-, three-, and five-year periods through May 2020.

Losers Not all Morningstar Medalist strategies were able to ride the second-quarter climb. Bronze-rated First Eagle U.S. Value FEVIX lost less than its S&P 500 benchmark in the first-quarter market pullback, but its defensive positioning held the strategy back during the market rebound. The large-blend strategy gained 12.7% from the start of the quarter through June 24, lagging its bogy by 7.0 percentage points. The portfolio's double-digit cash allocation and 13.6% gold stake as of March 2020 were the primary contributors to its disappointing rise over the quarter.

Bronze-rated Delaware Small Cap Value DEVLX typically fares better than most peers in market downturns, but the strategy lagged in the first quarter's down market and the second quarter's recovery. The strategy gained 13.2% from the start of the second quarter through June 24, trailing its typical small-value peer by 4.4 percentage points and the Russell 2000 Value benchmark by 0.3. The team's consumer discretionary picks such as Choice Hotels International CHH and Texas Roadhouse TXRH held the strategy back during the quarter.

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