Last year, Barron’s magazine asked ten top strategists to predict where the S&P 500 would end 2020. Their range was 3,000 to 3,700. The final number was 3,756 for a year-over-year return of 16.3%—much better than expected. Had the strategists possessed foreknowledge that a global pandemic would shut down the services economy and send unemployment numbers to the highest level since the Great Depression, I doubt we would’ve seen a single year-end target with a 3-handle.
But as of this writing, most markets are at or near all-time highs. That’s because the worst pandemic in the last hundred years was met with the largest global stimulus effort of all time. $15+ trillion of monetary and fiscal stimulus arrested a pending depression and kept economies idling while, in an ironic twist, the world’s most loathed industry quickly developed the literal shot in the arm the world needed. Now it’s a matter of getting the vaccine distributed. It was never going to be quick or easy, but we’re much further down the road today than anyone predicted nine months ago.
As it stands, we’re confident that the bull market that began in 2009 remains intact. To be clear, although the market fell 34% in March, it didn’t end the larger cyclical bull market. The COVID crisis was akin to a natural disaster, not a financial crisis or the bursting of a speculative bubble, which is why the stimulus was so broad and swift. Going into last February, the economy wasn’t overheating, credit conditions were good, liquidity was abundant, and equity investors were mostly complacent. Sure, there were some Robinhood YOLO types trying to get rich day trading Hertz and Kodak, but overall, equity fund flows were negative, as they have been for the last decade. That’s not what the end of a cycle looks like. There were certainly reasons for caution, and I laid out several of them in last year’s update, but that wasn’t a market crash call—just a tempering of expectations.
Looking ahead, economic and profit growth this year could be higher than expected, and many of the laggards of the last few years could become leaders. Companies in all industries have been cutting costs wherever they can, which is how they’ve posted record margins on revenue that’s down year-over-year. When revenues turn back up this year, there’s going to be real torque in the system. Already the energy and financial sectors are starting to show real signs of strength. If growth is stronger than expected, or less scarce to put it another way, then the high growth darlings may lose their sheen and the rotation to value could get legs. This doesn’t mean that the recent growth winners will become losers, but that the market’s gains will be more broadly distributed than in recent years.
Additionally, I think inflation will get more attention than it used to. Inflation expectations are steadily on the rise. Money velocity—or the speed at which it moves through the economy—is still depressed by historical standards. But savings rates are abnormally high due to fiscal stimulus and suppressed activity. As the economy normalizes in the latter half of this year, consumption could increase dramatically and with it, money velocity. This is especially true in light of the results from the Senate run-off races in Georgia. With a Democrat-controlled government, we can be sure that more fiscal stimulus is coming. Big infrastructure spending may follow. Speaker Pelosi called a $1.6 trillion bill “skinny” if that gives you any sense of scale. My condolences to fiscal conservatives, but the toothpaste isn’t going back in the tube. Modern Monetary Theory is here to stay, and we must all deal with the unintended consequences.
In an inflationary environment, long-dated bonds would underperform as interest rates are pushed higher. Additionally, high-growth names that had no competition in a low-growth world could stumble. Cyclical industries should do well, as should real assets like materials, commodities, and real estate. While most official measures of inflation are still benign, there’s plenty of anecdotal date to be found. Just look at used autos, lumber, RVs, precious metals, building materials, housing prices and freight costs. The only muted input to CPI is rent, and who knows how long that will stay down.
Our current positioning is aimed to take advantage of a cyclical recovery in the economy and building inflationary pressures. We’re reducing interest rate risk in our fixed income holdings and increasing protection against a steepening yield curve and an increase in fixed income volatility. The Fed may have their thumb on the scale now, but I wouldn’t be surprised to see a test of the new policy framework at some point this year. With GDP rebounding, the markets may test how committed the Fed is to keeping real rates low. The bond market has already priced interest rate liftoff in 2023, and a strong vaccine impulse could pull that forward.
We’re also bullish on international and emerging market equities in the intermediate-term. In periods where the US dollar is weakening, like 2000-2009, foreign stocks tend to outperform. China’s recovery is spreading to the rest of the Asia Pacific region, with the global freight index soaring to reflect export demand. Additionally, global financial conditions are the easiest on record.
We expect good things from 2021, even if we make no prediction about near-term returns. Lots of things will impact market performance over the next year: Will the vaccine be distributed quickly and work as well as expected? Could virus mutations set the clock back? Will interest rates rise or decline? What’s the probability for civil unrest, cyber attacks, a terrorist attack, or even war? We don’t know. That’s why we remain diversified, disciplined and patient, leaving room for the unknown. Here’s an excerpt from last year’s memo:
As of this writing, the slowdown risks to the economy, particularly for manufacturing and trade-exposed sectors, appear less threatening. If nothing else, the risks are well-enough understood and not likely to surprise anyone. And that is the key, because the riskiest events, and therefore the most consequential, are the ones we don’t see coming.
Over the last two years, the same risks have been repeated over and over: interest rate hikes, a flattening yield curve, the impeachment, the trade war, and the election. And while people might be worried about these things, nobody should be surprised by them. Business owners and CEOs might be frustrated, but many have prepared as well as they can. Paying attention to known risks is smart, but we should acknowledge that what we can’t see, what we aren’t talking about, and what we aren’t prepared for will probably be more consequential than all the known risks combined. That’s how risk works.
I followed the paragraphs above with this:
The case for optimism is that we have always muddled through these types of events in the past and we’ll likely always muddle through. The global markets and economies are incredibly adaptive.
It’s a sentiment worth repeating: optimism is still the only realism. If you have any questions or comments, please let me know. Until then, let me thank you again for being a client of SIMA Wealth Partners. It is a privilege to serve you.
Ashley Vice, CFA, CFP®– Portfolio Manager
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