U.S. Markets Stage Dramatic V-Shaped Recovery
- The S&P 500 gained 12.1% during the fourth quarter of 2020, helping the index return 18.4% for the year and reach all-time highs once again. Markets finished the year undeterred by a resurgence in COVID-19 cases, as optimism about vaccinations, clarity from the elections and low interest rates continued supporting market prices.
- During the fourth quarter of 2020, market leadership rotated from large cap growth stocks, which have led most of the market recovery since March, to value and small cap stocks. The Russell 2000 Value Index climbed 33.4% in the fourth quarter, while the Russell 1000 Growth Index returned 11.4%.
- Equity markets ended the year with significant dispersion across sectors. Online retail and information technology stocks within the S&P 500 finished the year up approximately 69% and 44%, respectively, whereas energy and airlines in the S&P 500 lost approximately -34% and -31%, respectively.
International Markets Outperform U.S. Market
- Equity markets outside the U.S. outperformed the S&P 500 during the fourth quarter, also fueled by relative outperformance in small cap and value stocks. Developed international equities as measured by the MSCI EAFE Index finished the fourth quarter up 16.1%, returning 8.4% for 2020. Emerging market equities ended the fourth quarter up 19.6% and up 18.5% for the year.
- Lower valuations amidst positive vaccine news as well as better handling of COVID-19 cases helped international markets outperform during the fourth quarter. In addition, during the fourth quarter the U.S. dollar weakened to levels not seen since April 2018.
Fixed Income Breaks Records in 2020
- Fixed income markets returned 0.7% during the fourth quarter and 7.5% for the year, as measured by the Bloomberg Barclays Aggregate Index. After reaching all-time lows of 0.3% in early March, 10-Year Treasury yields remained relatively stable through the last quarter, trading at 0.9% by the end of 2020.
- Negative yielding debt reached an all-time high of $18 trillion, with over one-third of global fixed income trading at negative yields. In addition, corporations issued record amounts of debt in 2020, totaling approximately $2 trillion in investment grade and high yield bonds. During the fourth quarter, investment grade credit nominal yields reached an all-time low of 1.7%.
- The Federal Reserve reiterated its intention to maintain low rates and committed to purchasing $120 billion of bonds on a monthly basis. Its revised target of 2% average inflation implies that monetary policy will likely remain stable until inflation runs “hotter.”
Commodities Stage Strong Recovery in Q4
- As measured by the Bloomberg Commodity Total Return Index, broad-based commodities returned 10.2% during the fourth quarter, helping commodities markets recover significantly during 2020, despite still finishing the year down -3.1%.
- Oil prices climbed during the fourth quarter, ending 2020 at $48.5/barrel. Agricultural and industrial metals rose dramatically in the fourth quarter, up 21.4% and 14.3% respectively, as measured by the Bloomberg Agricultural and Industrial Sub-indices. Gold remained flat during the fourth quarter, rising 0.7%, but appreciating 25.1% in 2020.
In a year marked with so much volatility, the markets were largely a source of stability and optimism in 2020. While the downturn in the early stages of the pandemic was sharp and at the time unsettling for many, the dispassionate markets were better equipped in many ways than the rest of society to see the COVID-19 pandemic and the other challenges we faced as things that would eventually be behind us. By year’s end, we could see that ultimately the intermittent ups and downs of the markets in response to the past year’s upheaval was part of a larger curve trending in a positive direction. With distance, the signal of the broader growth trend emerged from the noise of the rockiness of the road just behind us. The COVID-19 pandemic will likely remain the story of the markets, and our lives, into 2021, and the human cost can never fully be measured. But for now, the markets, at least, see brighter days ahead.
The Vaccine is The Light at the End of the Tunnel
After nearly a year of social distancing, mask-wearing and various degrees of lockdown, the vaccine is what finally signals a genuine hope that we are nearing a return to relative normalcy. The potential of a vaccinated populace brings with it the promise of open businesses, live sports and concerts and summer vacations, good for some major sectors of the economy aside from their value to our collective quality of life. This may feel like a recent development to many of us as we wait our turn for the vaccine and continue to stay at home to protect ourselves against the virus. Still, there is an argument to be made that the markets have been pricing in this eventuality for months. After the initial downturn in March hit bottom, the markets have been on a relatively steady upward trajectory, signaling that we are experiencing a V-shaped recovery. The inflection point was in late March, in the midst of congress finalizing the CARES Act and, in fact, the day some of the largest of the Fed stimulus programs were enacted.
Since then, markets have largely continued to trend upward, even as the pandemic continues and mitigation measures have tightened in many places in response, after an initial relaxation of some restrictions in the summer months and early fall. The S&P 500 rose to its previous historic high in the third quarter of 2020 and has not retreated in any significant fashion. This trend has been sufficiently pronounced to lead to 2021 estimates showing all S&P sectors expected to not only see positive growth over the next year but a majority to show positive growth relative to 2019. Global earnings growth estimates for 2021 and 2022 show potentially even stronger upward trends, after negative growth in both 2019 and 2020. While 2020 was often turbulent in terms of valuation, we now appear poised for a long-term positive trend as we would have expected prior to the pandemic.
Assuming that the markets have been pricing in this eventual recovery, both economic and medical, since the second quarter makes this trend seem more reasonable than it might otherwise but also cautions that we may not see as significant a market rally as vaccinations take effect and restrictions relax as might otherwise be expected, if much of that has already been factored into current values. That said, if pent up demand leads to significant consumer spending later in 2021, a steeper upward trajectory is far from out of the question.
Bird’s Eye View Tells a Much Different Story Than on the Ground
We have likely all been acutely aware of the week-to-week and day-to-day changes in our lives over the past year, and that has included some periods of wide market swings. While the year was in many ways marked by volatility and uncertainty, it is worth noting that from a 30,000-foot view, the long-term trend line of equity markets has largely recovered to pre-pandemic levels and better. Any curve will have some degree of volatility along the way, but it is the broader trend that the curve tracks that is more instructive. The S&P 500 closed 2020 up more than 16% for the year, an above-average showing historically, and the strength of the tech sector as we relied on streaming and teleconferencing and delivery services to get by pushed the NASDAQ up 43.6%1. As our lives slowly return to something resembling our previous normal, the current market rotation may correct itself, causing the gulf between the performance of tech equities and their traditional counterparts to narrow, but even the modest growth that the old blue chips have shown on average is a positive in light of the global conditions.
All of that said, it is difficult to look at the encouraging market performance and not think of the widespread economic difficulties caused, at least in large part by the pandemic. Individuals are still faced with job loss, small businesses that have hung on this long are still in peril and it is not unreasonable to wonder who is going to be there to spend the money when restaurants are fully open, concerts and live sports are scheduled, and travel is possible. As the virus surged again in late fall, leading to a return to stricter lockdowns in many areas, the Consumer Confidence Index in December dipped close to its lows from April and May.
It remains to be seen whether the recent stimulus payments and the promise of another round of larger payments soon will improve consumer confidence, or if the reality of the state of the pandemic will be in charge until cases are once again dropping and vaccination has further progressed.
If current valuations have already priced in a successful vaccination program and a return to relative normal at some point in 2021, one potential area to watch is the efficiency and effectiveness of the vaccine rollout. As of this letter’s writing, fewer than 20 million people have received at least one dose of a COVID-19 vaccine in the U.S., with fewer than 3.5 million people receiving two doses.2 While a delay in vaccinations does not change the ultimate outlook of an end to the pandemic in the reasonably near future, it could cause a slowdown in growth if the delay becomes significant and prevents the return of long missed activities like summer gatherings and holiday travel in 2021.
It is also fair to ask whether volatility around the presidential transition and the recent unrest may cause consumer confidence to stay relatively low, as some may see continued uncertainty and consider it a reason for caution. The household savings rate spiked to 33.7% percent in April, amidst the height of concern about job loss and business closures, and while it has decreased since, it has remained above the pre-pandemic and 2019 rates. For households that increased savings to prepare for the worst and have not had to tap into those reserves, this combined with vacations not taken and dinners out not enjoyed over the past year could signal pent up demand just waiting for an opportunity as we see the other side of the pandemic.
This pent-up demand may be particularly significant in international markets and lead to overperformance relative to U.S. markets in the near term, given that many areas across Europe and Asia, in particular, are further along in their recovery from the virus. European markets may also benefit from decreased uncertainty as the Brexit process finalizes. In addition, if the current market rotation in favor of tech were to shift, non-U.S. markets with less tech exposure may perform better than U.S. markets boosted heavily by the sector.
New Administration and a New Normal
As we have said before, markets hate uncertainty and have little attachment to any political party, and fourth quarter performance has largely supported that. While market trends have been mostly positive since election day, many questions remain to be answered as President Biden begins his term. While we now know that Democrats will hold the presidency and both houses of congress, it is by the slimmest of margins in the Senate. We still believe that this likely means that large scale changes in areas like tax policy will be on hold, especially as the Biden administration’s stated priorities focus on managing and recovering from the COVID-19 pandemic. Promised changes to the corporate tax rate may still be on the table, but the impact is likely to be offset by other factors, including improvement in international trade relations and potential infrastructure initiatives aimed at getting jobless Americans back to work.
The Fed has also signaled that interest rates will remain low for the foreseeable future until it sees significant progress towards meeting benchmarks in unemployment figures and inflation. They have also committed to continuing major monthly bond buys.3 If Fed policy remains in its current accommodative state as the pandemic subsides, that should keep markets in a strong position while giving economic indicators a chance to improve.
While market performance has been strong and looks to continue to be such, we are also still in the midst of a pandemic and the attendant crises. We remain cautiously optimistic about global equities but are also cognizant of the challenges of the ongoing low-rate environment. Balancing returns and risk is an important component of portfolio construction. As we continue on what we believe is the upward slope of the V-shaped recovery, we will look for opportunities that may present themselves during what may be an uneven recovery across global economies and markets as we find our footing in the world after the pandemic.