Investors in the United States have endured a tremendous amount of turbulence in 2020. We have experienced a large-scale worldwide pandemic for the first time in over a century; a highly contested presidential election; social unrest; a record quarterly drop in gross domestic product; and a sharp, fast decline in stock prices followed by a subsequent rise leading to record highs in most of the major indexes. Against this backdrop, we are often asked, “Where do we go from here?”
As noted investor and author Howard Marks says, “You cannot predict, but you can prepare.” How can you work in concert with your investment counselor to ensure your portfolio is prepared for 2021 and beyond?
As a result of the pandemic and the inability of many companies to conduct business during it, gross domestic product dropped 33% in the second quarter, then rebounded in the second half of the year to end the calendar year at negative 3.5%. It is important to note that while some businesses may have been decimated by the pandemic, others thrived, particularly those that serve the “work and stay at home” crowd, such as technology and delivery companies. Those citizens whose paychecks were relatively unaffected by the pandemic should be grateful, as so many others are in businesses that were closed and may not reopen even after the largest effects of the pandemic have passed.
For the overall U.S. economy, we might expect an above-average snap-back in the first and second quarters of 2021, followed by slower economic growth in the second half of the year and beyond, as the effects of anticipated higher individual and corporate taxes intersect with an increased willingness by the government to stimulate the economy.
In the fixed income markets, 10-year U.S. Treasury bond yields still sit at 1.07%, near historical lows. We are often asked if there are any safe places to earn the types of yields that were seen a few years back. Interest rates on bonds are largely determined by the time to maturity (a bond maturing many years from now generally yields more than a similar bond that matures in a shorter period of time), the credit quality of the borrower, and current and projected inflation over the time the bond has to maturity. In order to earn higher yields, the most likely route is higher inflation, which means the investor would be paying higher prices on the basket of goods that they currently purchase. We would say emphatically that investors should accept lower bond yields at this time, rather than purchase higher-yielding bonds and incurring significantly higher risk with their bond investments. We also believe that investors should hold shorter bond maturities than they normally would, as we are loath to be lending out your money for a longer period of time at these low rates. By keeping bond maturities shorter, an investor might well have the opportunity to reinvest sooner at higher rates and earn a better long-term rate of return.
To determine a path forward in a market such as this, historical perspective can help.
With stock markets at all-time highs, stocks are trading at the higher end of historical valuation metrics. Stocks also compete with bonds for investment capital, so lower bond rates can justify higher stock valuations, with all other factors remaining equal. To determine a path forward in a market such as this, historical perspective can help.
From 1925 to 2020, the stock market returned a compound annual growth rate of over 9%. Intermediate-term U.S. Treasury bonds returned 4%, a little less than half of the returns for stocks. Those 9% stock returns are not earned in a straight line, however; stocks are riskier than bonds, particularly the shorter the time horizon is of the investor. Over the aforementioned time period, the United States endured the Great Depression, World War II, the Korean and Vietnam Wars, the stagflation of the 1970s, the stock market crash of 1987, the internet boom and bust of the 1990s and early 2000s, the financial crisis of 2008, and the current pandemic. Despite all of those things, stock investors earned over 9% per annum over that period - double the rate of bond returns and triple the rate of inflation. Can an investor say with any assurance that the situation our country faces today is as dire as those that we just mentioned?
The long-term investor should remain sufficiently invested to enjoy the benefits going forward.
A look back at history should convince the long-term investor that it has not paid to be a pessimist regarding America and its economy. For nearly 250 years, our free-market system has unlocked the ingenuity of entrepreneurs looking to serve their potential consumers and their needs. Although our economic system does get off track from time to time, it has shown an amazing ability to correct itself and improve our standard of living. The long-term investor should remain sufficiently invested to enjoy the benefits going forward. Oftentimes, the failure to invest is the biggest investment mistake of all.
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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.
