January 07, 2021
Closing out one of the most memorable (yet wishfully forgettable) years in modern market history, stocks across the globe broadly finished the year with yet another positive quarter. Investors chased returns, looking beyond the near-term issues led by Covid, unemployment, and political divisiveness. Heading into 2021, attention has turned to the landmark achievement of manufacturing and delivering multiple vaccine treatments in by far the shortest gestation period for a vaccine protocol in history. Investors also felt some relief in the determination that Joe Biden will be the next President, with stocks posting a strong rally following the November 3rd election. Recent news that the Senate, House, and Presidency will be under one party control has not derailed the rally as the prospects of increased Federal spending have so far outweighed the likelihood of an increased tax regime.
This past year was remarkable in many ways. It is inconceivable that the S&P 500 Index gained 18% in a year where unemployment reached 14.7%! Maintaining the strong momentum following the Spring shutdown, the S&P 500 Index gained another 12% for the final quarter. That year-end rally completed a gain of over 70% from the market bottom in late March to the end of December, a dizzying series of gains following the sharp losses that began in February. Growth-style positions led the entire year returns, but in the fourth quarter we saw a notable transition in leadership to Value stocks (such as Industrials and Financials)- particularly after the elections in early November. The large Value index outpaced the Growth index by about 5% for the full quarter. Growth did not go away- we still saw big returns and ongoing sky-high valuations from specific companies (Exhibit A: Tesla, with a valuation premium rivaling any in history, was added to the S&P 500 at near year-end). But, a general transition towards higher dividends and finding lower valuations does seem to have some teeth. This transition has felt inevitable as the S&P 500 has become increasingly top-heavy. Consider that just three stocks, Apple, Amazon, and Microsoft, accounted for over 50% of 2020’s total S&P 500 Index returns. Investors now seem inclined to look for value, and Value stocks are a good place to start. With the VIX volatility gauge still quite elevated, this cautious approach seems prudent. We are nowhere near the levels of March 2020 yet, but the elevated VIX bears close scrutiny (no pun intended).
The Fed has continued to maintain its dovish tone, with Chairman Powell leading the charge to provide ongoing liquidity and accommodative rates. This approach could come under some pressure if/when we see inflation begin to rise, but in the near term the expectation is for the short-term Fed Funds rate to remain right near 0%. Signs of rising inflation expectations have begun to emerge, but rising inflation has been a siren’s song for over a decade. The 10-year rate did notably climb in the quarter, with the rate hovering between 0.85% and 0.95%, rallying further after the Georgia Senate results to over 1%. Bonds broadly provided some upside in the period, with investment grade bonds gaining about 1% in total return while the more aggressive High Yield index gained about 5%.
Looking ahead, eyes will be firmly locked in on the vaccine delivery and implementation process, and on what policy changes will come from the Biden administration. Even if we do see structural changes to income tax rates and other issues important for investors to consider, note that such changes do not happen quickly and it can be rash to take significant action based on speculation. There will also be heavy scrutiny placed on data about consumers, with both their willingness and their general capability to “get back to normal” following this unprecedented period of government intervention in their day-to-day activity. Savings rates have ballooned during the pandemic, and the market is depending on consumers to use these savings to restore corporate earnings to their pre-pandemic levels. This will be a key driver in the pace and level of economic recovery we can expect.
We have identified key data points in recent market commentaries. While these metrics can continue to be difficult to rationalize in this unusual environment, here is where they stand:
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