When we hosted 2020 outlook seminars last January, the coronavirus didn’t even make the “other risks” section of the presentation. By March, all bets were off and it was clear that our experience with the virus and the economic implications of containment efforts would get significantly worse before getting better. The shock to the economy and the markets was every bit as severe as may have been expected, but perhaps what wasn’t expected was the pace of recovery. Following a severe recession and sharp early rebound, the economy entered a period of longer-term recovery, while financial markets, forward looking as they are, closed out the year in record territory. Below, we offer our thoughts on the current state of the economy and markets and perspective on what the year ahead may hold.
Not Out of the Woods Yet
As we exit 2020, the US is adding between 1.0 and 1.5 million cases per week to more than 20 million cumulative cases and 350,000 deaths since the pandemic began. Case volumes are out of control, healthcare system capacity is at a breaking point and death counts are climbing to new highs. We have consistently said that the solution for a health crisis would be medical in nature and positive news on the vaccine front is reason for optimism heading into the new year.
In December, the FDA approved vaccine candidates from Pfizer/BioNTech and Moderna for emergency use, setting in motion a supply chain that was ready and waiting. Other vaccines in development by AstraZeneca, Johnson & Johnson, and Novavax are in late stage trials and could receive US authorization in coming months. In the US, 13 million vaccine doses were distributed and 4.3 million doses administered (1.3% of population) in December with forecasts eyeing 200 million distributed doses by the middle of 2021. We are not out of the woods yet, but we appear to be at the beginning of the end of the health crisis.
Record-setting Drawdown and Recovery in US Stocks
Entering 2020, domestic stocks climbed 5% to a February 19 peak before falling 35% in just 23 trading days. From the March 23 bottom, stocks climbed 68% through year-end notching a total return of more than 18% for the year. It was a wild ride, but an investor who had simply fallen asleep in February and woken up in December would be pleased.
We did not call the top or bottom, nor did we predict the magnitude or pace of the rally that would follow. We did encourage our clients to stay disciplined and we did encourage our advisors to diligently rebalance accounts on the way down and on the way back up. Maintaining the appropriate level of risk in portfolios based on long-term goals and each client’s unique financial situation ensures that they are not overexposed during a decline or underexposed when stocks move higher. Our strategy may sound boring to some, but its effectiveness was clearly demonstrated in 2020. Looking to 2021, there is arguably more short-term risk at today’s levels than there was six months ago, but in our view, no more than should be managed with proper long-term asset allocation decisions and discipline.
Bond Strength Welcome in 2020, But Unlikely to Repeat
Entering 2020, ten-year treasuries were yielding 1.92%, but the onset of the pandemic and subsequent flight to safety drove yields down to just 0.54% by early March and an eventual bottom of 0.51% in early August.
Yields moved gradually off their lows to 0.91% exiting the year – less than half of their starting level and bonds (as measured by the Barclays Intermediate Government/Credit Index) gained 6.4% for the year.
Optimism on the vaccine front has led to risk-on sentiment in the credit markets and interest rates that are higher than they were six months ago, but still extremely low. The Fed expects to keep short-term rates near zero through 2023 in an effort to support economic recovery. Low yields will create fixed income return headwinds, but the COVID episode has highlighted that long-duration government bonds remain the best asset class for diversifying equity risk, even when starting yields are low.
Long-Term Economic Recovery
GDP growth is reported quarterly in the form of a “seasonally adjusted, annualized rate” (SAAR). In the first quarter, real GDP declined at a SAAR of 5.0%, which means if first quarter GDP levels persisted for an entire year, they would be 5% lower than the year prior. In the second quarter, GDP declined at a SAAR of 31.4% before rebounding 33.1% in the third quarter and somewhere in the mid-single digits in the fourth quarter (data to be released on 1/28). In spite of the dramatic swings experienced during the year, 2020’s real GDP likely declined 3.5% relative to 2019, with 3.9% growth expected in 2021 against an easy compare.
Third quarter GDP growth of more than 33% may sound impressive, but the reality is that achieving 3.9% growth in 2021 will be a much more difficult feat. We’re not suggesting it can’t or won’t happen. We are suggesting that low hanging fruit has largely been harvested. That said, we expect the economic recovery to continue into 2021, though at a slower, less consistent pace, as scars from 2020 slowly heal with vaccine distribution supporting a gradual return to normalcy.
Jobs Returning, But Many Remain on the Sidelines
The pandemic wiped out nearly 22 million American jobs in a matter of weeks, causing unemployment to spike to 14.7% in April. The labor market recovered about 12 million of those jobs in the months that followed. Unemployment stood at 6.8% exiting the year, marking transition from an unprecedented level to a level with precedent. However, this rate of joblessness is still double the pre-pandemic low of 3.4% and more than 10 million previously employed workers remain out of a job.
After the initial record-setting level of job creation, it will take years to restore the balance that remains. Consistent with our longer-term recovery narrative, we expect 2021 to bring continued, albeit much less consistent, progress in the labor market. Distribution of approved vaccines will aid recovery in the hard-hit leisure and hospitality industry as travel gradually resumes and restaurants reopen. However, some industries will face the harsh reality of structural changes accelerated by the pandemic.
Retail Sales Recovered, But Consumers Remain Wary
Consumer spending makes up the majority of US GDP, so we pay close attention to retail spending levels and consumer sentiment. On a year-over-year basis, real retail sales declined 20% in April, but rebounded to year-over-year growth by June. Savings rates that initially soared amid boundless uncertainty, fiscal stimulus, and a lack of spending opportunities, fueled record levels of retail spending into year-end.
Looking to 2021, we believe the global vaccine campaign and gradual progress in the labor market will bode well for continued growth in real retail spending levels and the economy. Consumer sentiment has improved meaningfully from lows experienced in March and April, but remains well below pre-pandemic levels today. Overall, consumers remain cautious about their finances heading into the new year.
Looking Forward – Capital Market Assumptions
Source: Greenleaf Trust, as of 12/31/2020
We continue to recommend most of our clients hold a full weight to global equities in accordance with their individualized risk profile and we remain marginally more constructive on international equities. Concurrently, we are less constructive on the outlook in fixed income markets and believe a modest underweight in favor of an allocation to diversifying strategies (alternative assets) remains prudent.
Despite an ever-changing landscape, our disciplined approach and long-term orientation serve us well as we endeavor to create comprehensive investment solutions that help our clients reach their financial goals. Investment decisions are made in alignment with our documented investment philosophy and always with the intention of serving our clients’ best interests. Happy New Year and thank you from everyone on the Investment Research team for allowing us to serve on your behalf.