A Turning Point

Jan 5, 2021 | Newsletters

A Turning Point

Dear Clients and Friends,

At midnight on December 31, many of us cheered the turning of the calendar as a year of challenges took its place in the history books. We hope the new year will be a year of recovery—a turning point in public health, the economy, and the markets. We are expecting a year of contrasts, where vaccines crush a lethal virus, the economy heals, and market performance slows.

Markets anticipated a vaccine-led recovery in 2021, which led the S&P 500 18% higher in 2020 (and a blistering 12% in the fourth quarter). With so much excitement already built into the market, we might see more muted equity returns this year. Nonetheless, we recommend staying fully invested with an allocation appropriately aligned with your long-term objectives in order to generate at least modest returns on capital that exceed inflation.

Economy turns to growth

Healthcare workers and at-risk Americans began taking two Covid vaccines last month. We could see as many as five vaccines reach the U.S. by spring, boosting personal protection against the virus, improving consumer confidence, and leading to further and lasting reopening of the economy. As vaccinated consumers rediscover airlines, hotels, and restaurants, we expect the decimated travel and leisure industries to come roaring back . Massive hiring in these rebounding industries would put cash in the pockets of millions of unemployed people struggling to make ends meet.

We expect these trends to drive the unemployment rate down below 6% later this year, from a peak of roughly 15% in spring 2020. With more workers and companies back in business, we anticipate that the economy will grow more than four percent in 2021—quite an improvement from last year’s 3.5% contraction.

While jobs and growth are at a turning point, we see less dramatic movement for inflation and interest rates. Downward wage pressures may keep inflation under two percent this year (up from one percent last year). Additionally, as monetary stimulus from the Federal Reserve continues to drive bond buying, we expect sustained upward pressure on bond prices, keeping yields in a tight range. We expect the 10-year Treasury yield to remain around one percent this year.

Markets keeping a close eye on changes in PPE

During our Quarterly Market Outlook webcast last month, we focused on PPE—Politics, Policy, and Earnings –as important drivers for investor sentiment. One month later, this is where we stand with regard to Politics and Policy: With Democratic control of Congress on the line, the Georgia Senate runoff takes place January 5, though final results may trickle out if we get a close election. If Democrats win both Senate seats in Georgia, we could see a more activist agenda for President-elect Biden such as large-scale stimulus proposals, tax hikes, and green energy infrastructure spending. Alternatively, if the GOP retains Senate control, tax and spending plans may moderate.

As for earnings, we anticipate a recovery in hard-hit industries such as consumer discretionary and energy that could lead to 23% profit growth for corporate America (compared to a 17% decline in 2020). Investors may get an early taste of the profit outlook when companies start to report quarterly results in mid-January.

We generally agree with the mantra that stocks chase earnings, and with profits flipping to growth this year, does that mean markets could also power ahead? Unfortunately stocks generally chase future earnings, and in 2020 stocks surged in anticipation of the 2021 earnings recovery. With that in mind, we expect stock performance to be below trend this year, perhaps generating low to mid-single digit returns.

How are we positioning?

With low interest rates and modest stock returns in view, investors may feel a temptation to sit this one out and wait for better days ahead. However, we prefer time in the market, rather than timing the market—especially after what global investors experienced in 2020. Investors who became risk averse in spring 2020 likely missed out on a surprise bull market as the S&P500 rose 70% from late March to year end. Even if equity markets struggle to generate returns this year, we favor full investment allocations as dividends and bond coupons can help offset inflation.

As we look at equity exposures, we continue to review diversification. Large cap U.S. stocks are up more than five-fold since the depths of the 2008-09 recession. By comparison, other developed and emerging markets have only doubled in the same period. If the next ten years see a moderation in U.S. versus international performance, investors would likely benefit from non-U.S. exposure. Our preferred method for geographic diversification is owning multinational companies in targeted sectors such as technology and utilities, where we have begun to add positions and where we expect to broaden our horizons over time.

Markets have wrapped up another year, and we sit at what we believe is a global turning point—not only for PPE, but for the markets and the world in which we live. While we continue to face the daily challenges of Covid in the near term, we expect many favorable changes this year. These fundamental improvements may have a modest impact on markets in 2021, but our sense is a full economic recovery will set up companies for durable earnings growth post-Covid. With this in mind, we continue to evaluate opportunities for total returns that track improving corporate fundamentals. While these opportunities may present themselves in surprising ways (as they did last year), we remain committed to our core investment principles and ever mindful of your goals and objectives.

Wishing you and yours a healthy and prosperous New Year,

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President