This past year has been a period in history that many of us would like to simply forget. Concerns about our communities’ wellbeing led to a seismic shift in the way that we work, educate our children, socialize, and go about our daily routines. Without a doubt, 2020 has been a year that has tried our livelihoods, finances, health, relationships, and most importantly, our patience. Indeed, the one word that might best characterize an experience that happened to us is: survival.
Nevertheless, chances are good that the negative factors that have forced us to hunker down are likely to ease into the year ahead, enabling many of us to thrive once again. More specifically, widescale distribution of a coronavirus vaccine and a return to a seemingly normal political environment likely will foster greater business and household confidence in the months ahead. Such outcomes could support labor market improvements and a rise in business earnings. At the same time, accommodative central bank policy may provide much-needed support to the economy and boost financial market sentiment.
Even so, while government spending and money printing were a boon to financial markets in 2020, investing likely won’t be as simple as following the latest trading fad. Liquidity-induced momentum trades that provided handsome gains this year could be harder to come by in 2021. That’s why as we look into the year ahead, the key to thriving financially for investors with a long-term savings orientation could be as simple as sticking to the basics and focusing on fundamentals.
Climbing Out of a Hole
The healthcare crisis response dealt a blow to the US economy, but there are ample reasons to be optimistic. Nationwide lockdowns during the first half of 2020 led to one of the sharpest economic contractions in history. A record 24.9 million people had claimed jobless benefits this year as businesses closed to help stem the spread of the coronavirus outbreak. During this time, some economists expected a V-shaped economic recovery fueled by historic government spending and central bank money printing.
Indeed, while growth improved in 2020, the gains that some people had hoped for failed to materialize. And as 2020 ends, the healthcare crisis has again intensified, leading to a new round of stay-at-home orders, business closures, and a rise in unemployment. While the housing market certainly benefited as more individuals worked from home, much anticipated pent-up demand in consumer spending fizzled out into the holiday season. And while it appears that the economy is now losing steam, a couple of factors may pave the way for greater economic resilience in the coming year.
So why should we be optimistic? Well, to start, we now have several vaccines that put us miles away from where we were just a few months ago. These injections may eventually help mitigate the spread of COVID infections and enable society to return to some semblance of normalcy sooner rather than later. Certainly, news of a vaccine was greeted with optimism by the markets in November.
And as vaccination efforts kick off this month, there is a reason for optimism as social distancing orders are likely to ease at some not-too-distant point. Indeed, a recent CFO Survey from the Richmond Fed showed that business executives are more optimistic about the future than last quarter as they looked past pandemic risks.
Besides vaccines, another likely reason for rising confidence heading into 2021 is greater political certainty. With another chaotic election season behind us, Capitol Hill leaders are likely to focus on introducing policies that further support economic growth. While a $900 billion stimulus package was approved in December, slowing retail sales and rising jobless claims likely opens the door for another round of government spending during the first half of next year.
Make no mistake; the road to recovery will take some time. History has shown that, on average, recessions tend to last about three quarters. From there, it takes on average two and a half years for the labor market to return to its previous high-water mark. These data points suggest that the US economy has a deep hole to climb out of, so vaccination efforts and decisions made by Congress will be essential to the recovery pace in the months ahead.
The Markets Are Not the Economy
Let’s consider this economic outlook in the context of the markets. Now, there seemed to be a disconnect between financial markets and the economy in 2020. While household spending slowed and employment conditions declined, major stock market indices closed the year positively. To be sure, a repeated mantra reflecting this sentiment has been that the markets are not the economy. So why did markets perform so well amid a global pandemic? Well, without a doubt, global central bank policies played a crucial role in buoying risk asset prices.
During the height of the pandemic outbreak, the Federal Reserve (Fed) introduced a historic asset purchased program that dwarfed its previous money printing efforts. For example, in 2020, the Fed added $3.3 trillion worth of assets to its balance sheet. To put this figure into perspective, from the height of the Global Financial Crisis in 2008 and three rounds of Quantitative Easing thereafter, it took the Fed over five and a half years to purchase the same amount of assets. What’s more, the Fed, European Central Bank, and Bank of Japan bought a combined total of $8 trillion of assets this year, a feat that took eight years during the Global Financial Crisis. Arguably, this massive injection of cash into the financial markets contributed to stellar market performance in 2020.
Newly Minted Investors
Another contributor to the strong market performance was greater participation from individual investors. An analysis prepared by JP Morgan Securities suggests that individuals opened more than 10 million new brokerage accounts in 2020. Add in the rise of a cottage industry of social media investing gurus, the fact that some apps have arguably gamified investing and brokerages flush with cash offering attractive margin loans, and you have a recipe for exuberance in certain corners of the markets. This sentiment was particularly evident in the tech sector, which saw outsized performance as work-from-home and healthcare stocks benefited from Fed-induced liquidity and newly minted day traders.
Today, however, there’s some indication that this popular market approach may be losing steam. The momentum trade that had supported strong asset performance has subsequently led to stretched valuations. Such excesses have been exhibited more acutely in tech, which is up well over 40% compared to 16% for large caps. This preference for stocks poised to benefit from social distancing and work from home themes has come under pressure as a return to normal appears on the horizon.
Certainly, this perspective has not been lost on market participants. It has been exhibited in a rotation away from the liquidity-induced momentum trade towards more traditional cyclically oriented risk-on segments of the market. This shift in sentiment has also been evident in small-cap and emerging market stocks outperforming tech and a decline in the US dollar demand during the fourth quarter of the year.
Less Tech, More Cyclicals
Looking ahead into 2021, this sector rotation toward cyclical, risk-positive parts of the market could continue ahead of a recovery in the global economy. Even so, market optimism likely will be dependent on positive pandemic developments and a propensity for more fiscal spending.
More specifically, there is a risk that logistical and administrative issues related to vaccinations could lead to slower than anticipated uptake. For example, so far, only 3 million shots have been distributed and 11 million doses shipped — well below the Trump Administration’s goal of 20 million vaccinations before year-end.
Now, there is a potential that the bottlenecks contributing to the weak uptake in vaccinations could be resolved in the coming weeks. With that said, the longer it takes to inoculate the population, the longer that pandemic related risks will linger and put downside pressure on economic growth and corporate earnings. This point is important because market expectations seem to be pricing in significant improvements in the pandemic narrative by mid-2021, paving the way for a strong second-half economic recovery. Unfavorable developments that lead to a substantial deviation from this outlook could break sentiment and lead to bouts of heightened market volatility should the market narrative.
What’s more, there is a risk that a divided Congress could lead to more gridlock on Capitol Hill, potentially delaying plans for additional fiscal stimulus. Assuming that Democrats fail to pick up gains in the Georgia Senate runoff election, incoming President Joe Biden’s plans for a third round of stimulus checks could face a substantial roadblock. For example, the US fiscal deficit as a share of GDP is now at its highest levels since World War II. Fiscally conservative Republicans could derail plans for another stimulus package. Should this happen amidst an already weakening economic backdrop, we could see a rise in investor uncertainty and a bout of price weakness in an already stretched market.
Positioning Your Investments to Thrive in 2021
Without a doubt, the road to recovery from the Pandemic of 2020 will be fraught with many challenges. Even so, we could see a sustained recovery in employment conditions, household spending, and economic growth assuming inoculation efforts accelerate and policymakers remain supportive of more fiscal spending next year.
Such improvements likely would sustain higher corporate earnings growth and support investor demand for cyclically oriented portions of the markets. While following the trend has been an attractive way to play pandemic uncertainty, investors positioning themselves to thrive in 2021 likely would be best served by sticking to the basics and focusing on fundamentals.
For example, markets are arguably mean reverting by nature. This behavior implies that what has performed well in the past is not as likely to perform as well in the future. From this perspective, evaluate which positions in your investment portfolio have outperformed in 2020 (especially if those positions are tech-oriented) and consider whether it’s time to take some gains off the table.
Next, look over your overall investment plan and consider the composition of your holdings. As we transition away from economic survival and towards recovery, now may be the time to evaluate whether your portfolio is strategically aligned with your long-term savings goals.
Finally, get your savings plans back on track if this year’s survival strategy included avoiding contributions to your retirement plan. With prices at historic highs in certain portions of the markets, it may be tempting to wait for an attractive entry point before getting back into the markets. Even so, trying to time your way back into the markets could lead to missing out on long-term opportunities. That’s why dollar-cost averaging back into the markets might help you thrive financially in 2021.