Equity markets continued a torrid run in the fourth quarter, propelling nearly all sectors and asset classes back into the black for 2020. But Q4 was defined by a notable shift in market leadership as cyclical sectors and asset classes bested defensives and growth stocks. The backdrop for this shift was the continued broadening of economic growth as companies adapted to serve their clients even as COVID-19 intensified. The coronavirus is still advancing in the U.S., but a shrinking slice of the U.S. economy is absorbing the deepest impacts — namely travel, hospitality and entertainment. Headwinds to those sectors intensified in Q4 amid renewed lockdowns, but data show the remainder of the economy has remained resilient.

BROADENING BY SECTOR

Numbers from the Institute for Supply Management (ISM) Purchasing Managers Index tell the story. Both manufacturing and service sector firms reported rising new orders against a backdrop of extremely constrained inventories. Low inventories and growing demand are a recipe for future economic growth. Importantly, the ISMs show that this potent combination is appearing in a broad swathe of industries. Manufacturers have adapted and activity is humming, while some service industries are still sluggish.

Simply put, economic growth is clearly broadening, and that in turn is boosting earnings, ultimately providing the backdrop for a more inclusive stock market rally.

The manufacturing and service sector indexes together track a total of 36 unique industries. Through the fourth quarter, 31 of these industries reported growth. During the height of COVID-19 uncertainty in April, just four industries in the ISM indexes were growing. Q4 was even a sharp rise from the 14 industries that reported growth at the end of 2019, when the trade war was still impacting the manufacturing sector. Simply put, economic growth is clearly broadening, and that in turn is boosting earnings, ultimately providing the backdrop for a more inclusive stock market rally.

For another perspective, let’s look at the 11 sectors that comprise the S&P 500 index of Large-Cap companies. At the end of Q1 — or peak COVID-19 uncertainty — not a single S&P 500 sector was positive. As companies adapted and stabilized in Q2, two sectors turned positive. That rose to six by the end of Q3 and ultimately to 8 of the 11 by the end of Q4. Notably, of the three sectors that finished the year in the red, two of the three — cyclically sensitive energy and financials — were the best-performing sectors in the fourth quarter. Investors were peering into 2021 and began positioning for a full and broadly inclusive reopening of the U.S. economy, driven by vaccines from Moderna and Pfizer/Biontech.