Calendar year 2020 is over, and it will be one for the history books. The COVID-19 global pandemic, combined with a contentious presidential race and a polarized electorate, deeply affected our investment markets, economy, political landscape, and personal lives. The past 12 months were exceptionally challenging in many ways, and yet, looking ahead to the next 12, we see certain signs of optimism for investors that ought to be coupled with a dose of caution.
Annual stock returns for 2020 were impressive, despite a very turbulent spring for equity investors. The S&P 500 was up over 18% for the year, though readers of our past communications will recall that these returns were not evenly distributed. Certain companies and market segments have outperformed others. We believe portions of the market to be richly valued at this point. However, our research process is designed to identify quality investments with attractive valuations, and we continue to do just that.
From a broader market vantage point, we also see certain signs for optimism for investors, writ large. First and foremost, there is reason to think that the COVID-19 pandemic could be ending, or at least fading in its influence on our economy going forward. Researchers and scientists have developed a vaccine in record time, and the medical community has blessed it. The stock market is pricing in pent up demand for travel, leisure, and entertainment as consumer habits may normalize, and reported “Zoom fatigue” may point towards business spending and travel picking back up into the future.
For the U.S. consumer, economic fallout from the pandemic has been uneven. While certain workers and industries have suffered greatly, overall, we note an increase in personal savings rates which also have been boosted by government stimulus. Additionally, several years leading up to 2020 saw the biggest rise in real median incomes in decades. If and when our economy returns to “business as usual,” there are signs that consumer spending will return with it and that many consumers are actually in good shape.
However, the stock market has priced in this optimism resulting in increased valuations and expectations. High quality investments simply cost more to own currently. Moreover, though our election season is now over, uncertainty remains regarding specific legislative priorities and potential impacts for investors and markets, especially with respect to taxes. Democrats have taken control of Congress, and we anticipate further stimulus. However, the party’s narrow majority may result in a more moderate agenda. In this environment, we believe our process, which maintains a careful price discipline and favors companies with strong earnings records and cash flows, is pragmatic, if not fundamental for preservation and growth of investor capital.
We also note certain structural causes for caution within our markets and economy. While we expect 2021 to deliver GDP growth in the 2-3% range, we remain wary of the impact of mounting government deficits, future debt, and inflationary pressures. Since February of last year, the nation’s monetary base has expanded by $1.6 trillion, and the Federal Reserve has been clear that its intention is not to raise interest rates until 2023/24 at the earliest. At the same time, the federal budget deficit continued to expand last year, and we suspect it will remain large in 2021 as well. When national debt increases, there are structural incentives towards inflation, though too much inflation is neither good for the economy nor equity investors. Inflation can detract from stock returns, acting tax-like in certain respects, to cut into real investor profit. Additionally, because the Federal Reserve desires to keep interest rates low, bonds may offer a much less attractive risk/reward tradeoff in an inflationary marketplace. In other words, if bond rates do not keep pace with inflation, real return is diminished. As a result, we see mounting risk in longer term bonds, and we continue to desire to own shorter and higher quality debt.
At the turn of this unprecedented year and into the next, it remains our pleasure to work with you and translate our best thinking into your portfolios and plans. At Clifford Swan, we are grateful for the opportunity to serve you, and we believe now to be an opportune time to revisit your positioning and asset allocation with your investment counselor. Our goal remains to create customized portfolios to achieve your unique needs, and in this market environment we feel that is especially beneficial. Please contact us with any question, request, or concern. We wish you a happy, healthy, and bright 2021.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.