A Surprise Finish to 2020
Happy New Year! We hope that this letter finds you and your family well. Now that an extremely challenging year is over, we hope that 2021 means better days ahead for us all.
As tough as 2020 was on many levels, it was a very fruitful, albeit volatile, year for the markets. The S&P 500 finished the year up 18%, and the NASDAQ was up an astounding 44% for 2020. Even the Dow Jones index managed a 10% return, in what was a very tough environment for “old economy” businesses impacted more severely by the virus. US outperformance also benefited from a much higher concentration of gains among its largest stocks by market capitalization. A trend we have highlighted before, the contributions of the largest 15 US stocks accounted for nearly all of US returns.
On March 16, the market experienced a rare phenomenon in a true market crash (defined as a 10% or more drop in one day), when the Dow Jones Industrial Average declined just short of 13% (2,997 points), with both the S&P 500 and NASDAQ Composite down 12%. A one-day market decline of this magnitude had not happened since 1987, and represented the longest and most severe equity market losing streak since October 1929, with a four-day market decline of over 26% (approximately 6,400 Dow points).
Stocks, however, rebounded as quickly as the losses began. Since the low on March 23, the S&P 500 was up 70% through the rest of the year. The NASDAQ Composite returned to form even more quickly, and posted an 88% gain off of the low. In fact, shares of the Mega-Cap technology companies led the market out of bear territory and helped propel the tech-skewed Nasdaq Composite to a new all-time high in June, two months before the S&P 500 did so.
The economy’s nascent recovery gets much of the credit for the market’s rebound, as does a federal stimulus package, massive amounts of liquidity from the Federal Reserve, and the rapid development of multiple COVID-19 vaccines. The stock market rebounded so quickly because investors were encouraged that the pandemic wouldn’t trigger a more severe financial crisis. That assurance came from the Federal Reserve, which took swift and wide-ranging action to stabilize markets.
In fact, central banks around the world stepped up to add much liquidity, which allowed markets to step over the abyss. In 2020, over $9 trillion of monetary stimulus was injected into global economies, almost three times as much as was added during the Global Credit Crisis in 2008. The goal was to ensure that credit continued to flow to households and businesses during the pandemic, and that the financial system didn’t amplify the shock to the economy.
Meanwhile, in late March, Congress passed a $2.2 trillion stimulus package to put money into the pockets of Americans and offer relief to business owners. This was followed at year-end by another $900 billion package, which extends many of these benefits into 2021.
For all the consternation about the outcome of the presidential election and the makeup of Congress causing market volatility, politics didn’t end up mattering as much this year as did positive news related to COVID-19 vaccines.
“In our view, 2020 was a year in which great medical developments outweighed political developments.” [/pullquote]
As we begin 2021, those medical developments hold many of the keys to success for the economy going forward. As we write, two vaccines have been approved by the FDA and are being administered to certain patient populations. The speed and efficiency with which the general population becomes vaccinated sets the timeline for the economy to truly begin its recovery. Amid positive vaccine news, investors’ expectations for a full economic reopening have underpinned a reflation trade, driving Treasury yields and stock prices higher.
The stock market is forward-looking, and appears to us to have priced in a stronger economy and the arrest of the coronavirus pandemic by the second half of 2021. While this is somewhat reassuring, it does raise the risk that any disappointment in the recovery will spook investors. We expect many further bumps in the road and suspect volatility will remain persistent throughout the year. Most global economies enter 2021 in maturing recoveries, with a prospective economic reopening likely to lead to a broadening expansion as the year unfolds.
The winter rise in virus cases represents a strong near-term headwind, but is unlikely to cause a double-dip recession. Global monetary policy remains highly accommodative and supportive of asset prices, but the fiscal policy outlook is more uncertain. With higher asset valuations already reflecting positive expectations for reopening, financial markets may be influenced heavily by the trajectory of policy, inflation, and real interest rates. Therefore, some volatility is likely.
More recently, there’s been a slow and gradual shift as investors appear to be favoring value stocks relative to growth stocks. This is partly because tech stocks have lost some luster, as the prospect of these vaccinations makes a return to a pre-pandemic way of life more realistic. No matter which stocks are in or out of favor at any particular time, the market has surged in no small part because stocks offer comparatively attractive returns at a time when interest rates are near zero.
As always, we remain focused on the primary drivers of investment returns – corporate earnings and valuations. Expectations are for earnings growth to rise relative to the depressed levels of 2020, yet valuations appear to be stretched, particularly in the most popular of growth stocks. In addition, some of the technical indicators that we employ in our investment processes are flashing warning signs. While markets are pushing to all-time highs, money flows and relative performance are displaying divergences that give us some minor pause. Market leadership has continued to remain narrow, and our strategies have had the good fortune of exposure to some market leaders.
As always, we must remain disciplined investors, and we have and will be trimming position sizes to reflect the elevated risk levels of the current environment. As investors, it is important not to over-emphasize individual positions but to focus on your investment portfolios as a whole. It is our responsibility to remain disciplined, to not allow emotions to block our decision making, and to align our strategies with the risk management parameters that accompany them.
We are always committed to adjusting to an ever-changing landscape, performing sound research and exercising common sense. This involves not only individual security selection, but asset allocation and risk management decisions, with the goal of meeting your individual investment needs.
Please feel free to contact us at your convenience, to discuss your specific situation and how the various strategies that we offer can accommodate your needs. As always, we appreciate the trust and confidence you have placed in us, and we appreciate the opportunity to serve your investment needs.
Scott A. Goginsky, CFA
Sources: Index returns – Gemini Fund Svcs, Horan Capital Advisors; Market Crash – Seeking Alpha; Stimulus Bill – USA Today
The information set forth regarding investments was obtained from sources that we believe reliable but we do not guarantee its accuracy or completeness. Neither the information nor opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Past performance does not guarantee future results.