The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“Hope is a good thing…maybe the best of things.” — Andy Dufresne, from The Shawshank Redemption
Taking stock of a tumultuous year
Count us among the many who are saying “good riddance” to 2020 and happily turning the calendar to 2021. At the same time, we recognize that the past year taught some valuable investing lessons. Here are a few.
The stock market is most certainly not equivalent to the economy
The S&P 500 gained 16.3% in a year in which the U.S. economy had its sharpest and deepest recession since the Great Depression.3 Risk assets across the spectrum —high-yield bonds, equities, foreign currencies—generally surpassed our return expectations coming in to the year, before we had any sense of just how disruptive COVID-19 would be to our economy and way of life.
To what do we attribute this strong performance?
- The global recession was quite severe but also quite short. For example, after contracting in the first two quarters (particularly the second), both the U.S. and eurozone economies roared back in the third.4
- Economic recovery in the second half of the year was far stronger than anticipated thanks to heavy doses of fiscal stimulus from governments worldwide and unprecedented monetary stimulus from virtually every central bank. Policymakers have the toolkits to swiftly manage even a very severe crisis, so it’s no surprise that the Fed and its global counterparts were able to calm markets quickly while details about COVID-19’s potential damage were still forming.
- Incredibly rapid progress on the vaccine propelled markets higher in the fourth quarter, even as the global economy took a pause amid a severe second (or third) wave of the virus.
The lesson for investors: Don’t assume that headlines about the economy are a leading indicator for market behavior. If anything, it was the other way around in 2020. Of course, this also means that despite our expectations for GDP growth in 2021 to be the strongest in recent memory, we should not necessarily anticipate another excellent year for equity market returns. Some of that good economic news is assuredly already priced in.
Market timing is extremely difficult and rarely worth attempting
To successfully time the market, an investor must know precisely (1) when the market has peaked and (2) when it’s bottomed. That’s a tall order under “normal” market circumstances, and in a year as unpredictable as 2020, the challenge was even more daunting.
Consider: Investors who pulled money out of financial assets in mid-February and put it all in cash as concerns about the virus grew may have felt they’d done the right thing — until about March 23. That date marked the nadir for global equity markets and the beginning of a “risk on” rally that lasted the rest of the year, with plummeting volatility. The S&P 500 soared 68% over that stretch of more than nine months.5 In stark contrast, cash and short-term fixed income instruments generated meager returns. Bottom line: by year-end, shuffling funds into and out of investments or waiting for market dips to deploy cash led to permanent portfolio losses in 2020 — missed gains that can never be recouped.
Market leadership is not constant, making diversification important
As they’ve done nearly every year over the past decade — including 2020 — U.S. stocks outperformed non-U.S. shares, and growth trounced value.6 But while that was true for the year as a whole, it was very much not the case in the latter part of the year. Amid the global cyclical upturn, value stocks quickly found favor, and the falling U.S. dollar pushed emerging-and even some developed-market equity indexes ahead of the U.S.7 (A weak dollar boosts returns for non-U.S. stocks when translated into dollars.)
In fixed-income markets, what worked in the first half of 2020 — tilting portfolios toward longer-dated bonds (which rallied as yields fell) and higher-quality overall — hurt in the last few months as riskier assets such as U.S. high yield and emerging-market debt performed well.8 Such a rapid turnaround can whipsaw portfolios that are not adequately diversified.
Where does that leave us as we enter 2021? We’re not inclined to promote New Year’s “resolutions” per se, as they seem difficult for some folks to keep and often fall by the wayside. But we do urge investors to stick with principles that have stood the test of time, year after year: tune out “headline noise,” keep to a long-term plan and, of course, stay diversified.
Help is (finally) on the way
After allowing many of the provisions of March’s CARES Act to lapse over the past several months, Congress on December 21 passed a fiscal relief bill that the president criticized but finally signed into law nearly a week later. Most of this $900 billion package, part of a $2.3 trillion bill that also funded government operations to avert a shutdown, simply replenishes already existing programs such as the Paycheck Protection Program (PPP) for small businesses and enhanced federal unemployment benefits.
The jobless benefits, which add $300/week to what individual states already provide, should help offset a softening labor market by keeping many unemployed workers from falling below the poverty line. Moreover, recipients tend to spend the money quickly on essential items, which is good for the economy. The additional sum will be paid only through March, so we believe another tranche of assistance will be needed.
Under a separate provision, the federal government has already begun to directly deposit relief checks of up to $600 per person—phased out at higher levels of income—into bank accounts. The $600 figure, representing only half the $1,200 amount sent out in the first round of stimulus checks under the CARES Act, was a compromise to gain enough votes for the fiscal package to pass. Since its passage, the president and House Democrats have been urging Senate Republicans to increase the total from $600 to $2,000. As of midday on New Year’s Eve, the odds of that happening remained unclear.
Regardless of the amount, the second round of checks is the least important factor in our U.S. economic outlook, given our expectation that most of this money will be saved, not spent, just as we saw with the first round. High savings rates and low household debt are additive to the long-term health of the economy, but neither is likely to boost GDP growth in the near term.
In our view, a successful vaccine program remains the best source of economic stimulus for a sustained recovery. But this relief bill can help the economy from declining further while the doses are administered. The pandemic has worsened enough in the fourth quarter to bring large segments of the U.S. economy to a halt. Consumer spending, which makes up about 70% of GDP, fell in November and was revised downward for October. And we expect this coming Friday’s employment report to show minimal, if any, job gains last month.
But we believe better news awaits. December and January may well represent the low ebb in this latest pause — or dip — in economic activity. As the number of new COVID-19 cases begins to fall, consumers will feel more comfortable engaging in a wider array of commerce, eventually including the travel and leisure activities they’ve largely avoided over the past nine months.
Against this backdrop, we remain optimistic about the likely pace of economic improvement in the second quarter of 2021 and beyond. Among the positive trends we anticipate is for the unemployment rate to fall substantially further from its current 6.7% as workers are rehired in formerly distressed industries.9 Accommodative monetary policy and, now, greater fiscal commitment, have set up the U.S. economy to roar once the virus is behind us.
It's less clear to us that financial markets will roar in 2021, simply because much of the good economic news on the horizon has already been priced in, to some extent. Low interest rates are here to stay, for now, which should support equity and credit markets. And corporate earnings are set to bounce back strongly from their 2020 dips. Even so, with the opportunity cost of being un-invested still high (cash rates are virtually 0%), we think asset classes at the riskier end of the spectrum — including U.S. small-cap stocks and emerging market equity and debt — will continue to perform well.