The Year of Living Dangerously

If we took a poll, most people would respond that they would not have ever imagined a year like 2020, nor would they want to relive it.  But despite the human, social, and economic toll this “Year of Living Dangerously” has wrought, there have been some silver linings along the way: more time spent with family, working from home, no business travel, quality time with the pets, more beach walks and sunsets, and, oh yes, rocketing financial markets.

Since the stock market bottomed on March 23, 2020, the S&P 500 rose 68 percent, shattering records along the way and ending the year up more than 18% on a total return basis.  The performance of the tech-heavy NASDAQ Composite was even more impressive, up almost 45% in 2020, as technology companies became the saviors of the pandemic, providing the digital infrastructure to keep many businesses and the consumer economy afloat.

Stimulus and Vaccines to the Rescue

The market’s resurgence was fueled by the largest federal government stimulus package ever, the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, totaling $2.2 trillion, with more checks on the way. There was also historic support from the Federal Reserve buying financial assets and cutting rates to zero. There is also optimism about a full reopening of the economy once vaccines become widely distributed.  As Ryan Detrick, chief market strategist for LPL explains, “stocks are a forward-looking mechanism”.  The stock market is looking forward to a significant economic bounce in 2021 as the economy reopens armed with effective vaccines.

Bifurcated Economy

The market rebound reflects economic optimism about 2021, but it also underscores the disconnect between the financial market’s success and struggling American households, creating a bifurcated economy of “haves” and “have nots”.  As of year-end, there were an estimated 19.6 million Americans receiving unemployment benefits and U.S. Census Bureau survey data in November and December reports 27 million adults did not have enough food to eat.

Meanwhile, the “work-from-home” crowd has remained relatively unscathed economically by the pandemic.  Those that kept their jobs experienced a major boost in savings as they spent less on dining out, travelling, entertainment, and gas.  It is estimated that household savings increased by more than $1.3 trillion this year, boosted by stimulus checks and reduced discretionary spend.  In 2021, that is going to create a huge economic tail wind of pent-up demand.

There have not only been “haves” and “have nots” among American households, but, as Invesco’s chief global market strategist Kristina Hooper points out, among American businesses as well.  Large corporations have fared better than small businesses, and companies tied to the virtual, as opposed to physical economy, like online retail, have not just benefited, but thrived.

Small Caps Catch Up

Interestingly, small cap stocks, as proxied by the Russell 2000 Index, enjoyed their best quarter in history in the fourth quarter of 2020, up 31.4%.  Positive vaccine news was a critical component of this small cap rally, as investors looking ahead to the new year, expect a more level playing field in the coming year.  The rotation into small cap was also sparked by favorable relative valuations relative to large cap peers.  Which begs the question, are market valuations too high?  Is it too late to join the party in 2021?

JP Morgan shared a great study on investing at all-time highs.  Looking at the cumulative total returns over the last few years, investing on any day and investing at all-time highs, yielded about the same results.

High highs

So, particularly given the post-pandemic tailwind, perhaps investors should not be overly concerned about peak-level market valuations going into the new year.

Predictions for the Year Ahead

Obviously, 2020 was an example of how market predictions are often hard to make. So with the greatest of humility, I will try and forecast what areas of the market should benefit in 2021.  As mentioned, barring any vaccine setbacks, we are very bullish on the market overall.  There is huge pent-up economic demand and the liquidity to support it.  Many of us feel like our lives were on hold in 2020, and will be looking for some “adventure” in 2021.
Here are our predictions for the themes and market segments we expect to benefit in the coming year as the economy reopens and a new political regime takes power:

Re-Opening Themes

• BEACH stocks – Travel Bookings, Live Entertainment, Airlines, Cruises/Casinos, and Hotels/Lodging.
• Sit-down dining restaurants.
Biden Administration Beneficiaries
• Green energy and infrastructure
• Electric vehicles
• Cannabis
• Digital currency
• ESG

Equity Positioning

• Overweight small caps over large caps.
• Overweight emerging markets over developed markets.
• Growth will continue to outpace value (using traditional measures) as the new data, brand, and IP-driven intangible value economy leaves the old tangible value economy in the dust.
• Energy stocks may rally on the pick-up in economic activity, but the long-term trend is not their friend.
Fixed Income Positioning
• Given negative interest rates, investors should avoid short-duration in the face of a steepening yield curve.
• We are currently recommending an average duration, but will look to increase duration as yields move higher.
• As no recession looms on the horizon, investors can selectively reduce credit quality in favor of higher yields.
• Inflation protected bonds like TIPS are particularly attractive as inflation ticks higher in a recovering economy.
• The weak dollar favors some global bond diversification.
• Avoid high yield bonds given their high equity correlation and energy stock exposure.

Here is to a much more “normal” 2021 where kids go to school in person, we can travel to see our grandkids, go to the movies, visit Disneyland, and see our favorite group in concert.  The biggest silver lining of the 2020 pandemic, is that these are freedoms we will savor and never take for granted again. If 2020 was the “Year of Living Dangerously”, let’s make 2021 the “Year of Living Life to the Fullest.”  That being said, there will be many permanent outcomes of the pandemic.  We will be writing about how to position for those, in the coming months.

[1] The Year of Living Dangerously was a 1982 Australian romantic drama film directed by Peter Weir, starring a young Mel Gibson and Sigourney Weaver.  “Vivere pericoloso” is a phrase in Italian meaning “to live dangerously” popularized by Indonesia’s first president Sukarno in his Indonesian Independence Day speech of 1964.  It was made roughly a year before the 30 September Movement coup.

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