Goodbye 2020! Hello 2021!
2020 is a year most of us won’t forget, even though we might want to. From COVID-19 to shutdowns and reopenings to more shutdowns, elections, and impeachments — last year was one for the history books. As for the economy, no one anticipated the history it made. The second quarter resulted in the worst decline in Gross Domestic Product (GDP) ever (down 31.4% quarter over quarter) and was followed by the largest quarterly increase in GDP ever (up 33.4% quarter over quarter). Overall, the US economy will shrink by about 5.0% in 2020, which is massive when you consider that real GDP only declined 4.0% during the Great Recession of 2008-09.
With such a dramatic hit to the economy, you’d think the stock market would have experienced a terrible year too, right? But of course, it didn’t! This is 2020! The S&P 500 returned 18.6% (including dividends) for the year. Mid-cap stocks, small-cap stocks, international stocks, and emerging market stocks were positive too. Bonds were up about 7.4%, as measured by the Barclays Aggregate Bond index. It was a good year for most investments no matter which way you slice it. How is this possible?
There are at least three things that possibly contributed. First, in February/March the stock market was pricing in a global depression much like what occurred in the 1930’s. In fact, the S&P 500 fell ~35% in the span of a month (another record). The first stimulus bill was passed in April that pumped nearly $2 trillion into the economy. That stimulus bill likely averted a depression scenario and gave investors the signal needed to lift hopes and take stocks to new highs. It’s possible that had COVID not happened, and no stimulus occurred, the stock market would be lower than it is today as we were approaching the end of an economic cycle.
Second, COVID has accelerated a lot of trends that would have likely played out over many years into only a few months. The work from home, shop from home, never leave home economy resulting from the pandemic benefitted many of the largest companies. This helped the stock market continue to climb since the larger companies make up a greater portion of the S&P 500.
Lastly, many investors are likely suffering from TINA. TINA stands for “There Is No Alternative.” The Federal Reserve quickly dropped rates to near zero on top of the massive stimulus enacted by Congress. This has made cash, bonds, and CD’s so low yielding and unattractive for many investors that it’s almost necessary to increase risk by investing in high-yield bonds and stocks to find reasonable return. The Fed has also signaled that they will be accommodative by keeping rates low for years to come.
CHART ONE: Sources: Compustat, FactSet, Standard & Poor’s, J.P. Morgan Asset Management
When you boil things down, what likely happened in 2020 is that the market pulled forward much of the stock market return that might occur in 2021. The market is anticipating the world economy to reopen in the second half of 2021, and as it does, earnings may bounce back like a coiled spring as consumers return to doing what they do best – spending (perhaps even at higher levels than in the past due to the psychological impacts of 2020). It’s possible everyone will gladly splurge on that big trip or large purchase once the pandemic is behind us (the Roaring 20s did begin after the 1918 Spanish Flu pandemic). This is being reflected in earnings estimates as well. In fact, 2021 earnings are expected to be better than 2019, and analysts see a very big jump in 2022 earnings.
However, it’s still uncertain when the reopening will occur. If the vaccines roll out slower than anticipated and COVID-19 lingers into 2022, the markets could have a negative reaction. We are playing a dangerous expectation game; threading the needle in 2021 will be very important for the markets to continue higher. A reopening that occurs slower than anticipated will likely be combatted with further government stimulus in the form of more direct checks to consumers and the expansion of unemployment benefits.
Our baseline expectation is for the full economy to begin reopening sometime in the second half of 2021 followed by a large economic “release” of pent-up demand. Our hope is that it comes in 2021, but if that release is pushed to 2022, expect market volatility occurring around news of timelines being pushed back.
Finally, we believe that international investments could benefit from a weaker dollar as the year moves along. President Biden will implement a much different foreign policy when it comes to trade and globalization. An open trade policy would put more dollars into the international economy (since we have trade deficits with most of our trade partners) and this could force the dollar lower. Also, the Fed’s accommodative monetary policy should keep a lid on interest rates which could be a second headwind for the dollar. These headwinds for the dollar are typically tailwinds for international stocks. We might finally see a shift to outperformance in these stocks after years of waiting.
To hear more from KWB regarding our market outlook, please join us on Tuesday, January 26th at 9 a.m. for our 2021 Economic Outlook panel. As always, if you have any questions please contact us and stay safe.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Investing involves risk including loss of principal.
No strategy assures success or protects against loss. The economic forecasts set forth in this newsletter may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Investing involves risk including loss of principal.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa. Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
The S&P Midcap 400 Stock Index is an unmanaged index generally representative of the market for the stocks of mid-sized US companies. The S&P Small Cap 600 Index is an unmanaged index generally representative of the market for the stocks of small capitalization U.S. companies. The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
The S&P Small Cap 600 Index is an unmanaged index generally representative of the market for the stocks of small capitalization U.S. companies.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.