“Today’s headlines and history’s judgment are rarely the same.” – Condoleezza Rice (Former US Secretary of State)
“Life and investing are long ball games.” – Sir John Templeton
2020 in Review – A Year Like No Other
What a strange year of twists and turns. We aren’t just speaking as investors, but as humans. When the ball dropped over Times Square there was a sense of optimism in the air about what 2020 would bring for investors. If you recall, 2019 was a banner year with every major asset class we follow posting up solid gains. The economy was still doing well, if not quite as strong as it had been the previous two years. A tight jobs market was finally helping working wages edge higher. Confidence in the economy and the markets were both posting historically high levels.
Under the surface, but also out in the open, we now know, was the makings of one of the strangest years we can recall. By the second week of March COVID-19 had essentially shut down the global economy. Both US and global markets sold off hard. Never had the US markets lost 30% of their value in such a short period of time. Some panicked as others wisely sat on their hands. Policymakers tapped both fiscal and monetary policy, an economic lifeline for both businesses and citizens alike. Stock markets responded by rebounding almost as fast as they fell. Policymakers, it appears, learned the lessons of 2008.
Putting the drama aside, 2020 turned out to be a good year for investors. The stock market indexes we follow all ended the year with positive returns. The bond market remained robust. Commodities, on the other hand, were decidedly negative for 2020. Given the economic backdrop this comes as no surprise. The question now is, where do we go from here?
U.S. & International Stock Index Returns
|Index December 2020 Year-to-Date|
|Dow Industrials 3.39% 7.27%|
|S&P 500 4.16% 16.26%|
|S&P 400 (Midcap) 6.70% 11.81%|
|S&P 600 (Small Cap) 8.26% 9.57%|
|MSCI World 4.33% 13.89%|
|MSCI EAFE 5.28% 6.11%|
|Bloomberg Agg. Bond 7.41%|
|CRB Commodity Index (9.68%)|
|US Dollar Index (6.73%)|
All data as of 01/04/2021, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
2021 – The Elephant in the Room
“For every complex problem there is an answer that is clear, simple and wrong.” – H.L. Mencken
Just as 2020 was a year like no other, 2021 also has the potential to be like no other. With COVID-19 still not behind us, how we remember this year will be a direct result of how the pandemic response plays out in the coming months. We entered 2021 with some areas of the world turning the corner as others have not been as successful. The United States falls firmly in the latter camp. Just as past performance doesn’t indicate future returns for investments, we do have the ability to turn things around. On January 20th President-elect Biden will be sworn as President of the United Sates, which brings with it a new approach to handling the pandemic. Specifically, the new administration will focus on a new team of advisors with pandemic experience along with a new economic stimulus plan proposal.
Ideally, Congress will pass the stimulus plan to make sure that there is enough money available at the state and local level to provide the infrastructure to inoculate the populace and prop up those who have suffered the most from the pandemic’s economic effects. The best case scenario would see a notable increase in both production of the currently available vaccines while new vaccines get FDA approval for use. Such a situation would set up a reopening of the economy as we enter the second half of 2021. Those with the means will start to reengage with the economy, dining out, travelling, and getting on with life. Those in the service sector who have suffered will be back to work, earning a living once again, digging out of the financial hole they were forced into. By the end of the year, things will be “normal” once again.
Keep in mind, we don’t live in an ideal world …. Or a simple one …
More realistically, in our opinion, will be some form of economic stimulus that takes time to move through Congress as the two sides argue about the details while vaccinations continue. There will be many bumps in the road. The rebound isn’t likely to be as robust as hoped for, yet still surprisingly strong due to pent up demand. People will continue to suffer and unemployment will continue to be above average. Keep in mind, this realistic scenario isn’t all that bad.
How Much Will the Economy Grow in 2021?
That depends on who you ask. The FOMC is projecting real GDP growth between 3.7% and 5.0% while Goldman Sachs sees 5.9% 2021 growth. Merryll Lynch projects 2021 at 4.6%. All of these are very good numbers, but as Bill McBride reminds us, this is all dependent on how we handle the pandemic.
For the past few months we have really focused in on the changes we have seen in the markets. For years the trade was simple – overweight a small number of large technology companies’ stocks and ride the wave to strong returns. This trade accelerated with the pandemic because growth in the economy evaporated. In times like 2020, what typically happens is money flows to the few areas where earnings and earnings growth remains. As Jim Cramer’s tagline reminds us, “there’s always a bull market somewhere.” In 2020 the bull market was in large tech and healthcare.
But something has quietly changed. Since September the trends of 2020 started to turn a different direction. Those companies that had dominated were treading water at best, losing value at worst. Areas of the stock market that looked like dead money has started to come to life. The stock market is forward-looking, typically 6 to 9 months down the road. What this means is right now the stock investor should be thinking about what the world will look like this summer and fall, not next Tuesday. Next Tuesday is totally irrelevant. You need to forget that the next few months will likely be pretty terrible and start thinking about those economic growth projections. Even if you take the pessimists view and cut the projections in half, growth should be coming in the second half of the year, still giving us a bad to good scenario.
Investing in 2021 – a New Approach
We have been talking about the changes we have been seeing in the markets for a few months now (October, November). For years the stock market indexes we follow have been driven higher by the outperformance of a limited number of companies, many within the information technology space (“tech”). We do believe that technology is still a very interesting area for investment, but the time has come for a different approach. The few stocks that have done well over the past few years – those that have grown to have very large market capitalizations – have mostly been lagging since September 2020. Makes sense to us, given the growth of both the size of these companies and the expanded valuations put to them. We do not view them as bad companies. Quite contrary, we do think they are and will continue to be great companies. We also know that great companies are not always great investments.
Small cap stocks, along with a number of sectors, have lagged the overall market for a number of years. The pandemic exasperated the situation with money flows into the “winning” areas of accelerating. A reversal, in our opinion, has taken hold. The anticipated reopening of the economy in the coming quarters has started the change. The continued move towards “normal” will help the trend endure.
International stocks are also a favorite area for us as well. Specifically, within the international space, we are more positive on the emerging markets. On a relative basis emerging markets have been outperforming the S&P500 since the beginning of June (Chart #2). In our experience, this is a trend that lasts multiple years, not multiple months.
The bond market is a much trickier situation. The FOMC has pegged short-term rates at low levels with an acknowledgement that there will be no change in policy for the next few years. To translate: do not expect to receive very much interest on your cash savings for the foreseeable future. What is interesting to us is where rates go on the longer end of the rate curve.
Chart #3 shows the yield on the 10 year US Treasury bond which has been steadily rising since August 2020. Chart #4 is a look at the spread between the 10-year Treasury and the 2-year Treasury bonds. You might take notice of the similarity between the two charts. Th reason for this is that the spread has come as a result of the 10-year yield increasing as the 2-year rates have held relatively stable. The widening spread is positive sign for the economy, but a tough investing environment for the bond investor. Given the low yields at all levels, (the 10-year Treasury is just getting back above 1%) even a small move in the price of a bond can wipe out any gains one makes in interest (generally speaking, when interest rates go up the price of fixed-rate bonds goes down).
What’s an Investor to Do?
“Compounding is not about earning the highest returns. It’s about earning pretty good returns for the longest period of time possible.” – Morgan Housel
Every year we are faced with this question of what should an investor do in the coming year. For 2021 we do see a change in direction and some tactical changes will do a portfolio some good. The key word in that last sentence is TACTICAL. We at NOT advocating selling off your large cap stocks and holding a equity allocation of small cap and emerging market index funds. That would be a bet, not investing. No. What we are advocating is maintaining an asset allocation but adjusting it to what we believe is a new reality. We do believe we are correct, but what if we are wrong? What if COVID-19 takes a turn for the worst and our sunny projections don’t pan out?
The honest answer is that we are making an educated guess that is subject to change as the year plays out in real time. This is more pertinent in 2021 than any other time we can recall. When we entered 2009 the market was crashing, but the issues were known and quantifiable. Fixable. The pandemic is fixable but the path to a solution isn’t so straight. This elephant in the room is still there – and will be for some time.
To sum it all up, the wise investor will hold a variety of asset classes with an eye on risk, and an understanding that success comes to those who have been consistently good. The wise investor understands that boring investing wins the day. In baseball terms, you want to hit singles and doubles, not swing for the fences.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Magellan Financial, Inc. is a separate entity from WFAFN.
Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Jeffrey T. Bogert, Partner
Robert I Cahill, Partner Rob.Cahill@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com