CIO Insights – Turning the page on 2020
Economic snapback to fuel global growth. We have a very optimistic outlook for 2021, with above-consensus GDP calls around the globe. We expect global growth of over 6%, with growth in the U.S. and Europe of between 5% and 6%, while China and India could see growth of 9% or higher. We expect this growth to be driven by a rebound in economic activity as pent-up demand is unleashed with consumers able to again spend in areas of the economy that are currently impacted by the COVID-19 pandemic.
While there is no minimizing the economic pain the virus is causing, we fundamentally believe much of the weakness in the economy stems from a lack of opportunity to spend not a lack of ability to spend. Several sectors of the economy, such as entertainment, travel and restaurants, currently remain extremely restricted, keeping consumers from spending in these areas. However, consumers in aggregate continue to have disposable income sufficient to fuel their desired level of spending. This has elevated the savings rate to an unsustainable level. The pre-virus savings rate hovered around 7%, spiked above 30% during crisis and was running around 13% as of November. The most recent stimulus package will likely push the savings rate back up, further bolstering consumers as millions of people will see $600 stimulus checks and additional unemployment assistance. That relief is likely to help sustain consumer spending as we move toward a return to normalcy.
If we break out spending into durable goods, nondurable goods and services, the impact of pandemic-related spending restrictions becomes evident. Spending on durable goods is roughly 13% above pre-virus levels, while spending on nondurable goods is roughly 4% above. However, spending on services is still down roughly 6% since the onset of COVID-19. As we move through the year and vaccination levels lift us toward “herd immunity” resistance levels, we believe some service categories will start to normalize, which is likely to trigger a sharp upward inflection in growth. We expect to see the biggest rebound in sectors that have suffered the most under COVID-19 restrictions. Recreational travel should see strong demand once the public feels comfortable traveling again. However, we believe business travel will probably be slower to recover as corporate America has learned work can be done remotely. Movie theaters and other entertainment venues also are likely to bounce back as vaccination levels rise. Finally, we would highlight restaurants. Sadly, many eating establishments have not survived the pandemic, but those that did could see share gains in addition to strong demand.
We expect this snapback in growth to begin late in the first half of 2021 and extend into the second half of the year. This should be the strong point for growth not only in the U.S., but for developed markets globally as well as for China. We expect that larger emerging market economies will probably lag this return toward normalcy by about one quarter, while smaller emerging market countries will be the last to see a return to normal.
Monetary policy to remain stimulative. Despite our bullish outlook for growth, we expect global central banks will be very cautious coming out of this environment. Policymakers have made it clear they will err on the side of caution and not tighten preemptively, in order to avoid disrupting the recovery. The Federal Reserve (Fed) has made what we believe is a critical change in its framework for looking at maximum employment and inflation. The Fed will now look at employment through the lens of “broad-based and inclusive goals” instead of just targeting an aggregate unemployment rate. This involves examining employment rates among various ethnic and racial groups and trying to drive down the unemployment rates of these diverse groups.
On the inflation side, after having missed its 2% inflation goal in all but a handful of months over the past cycle, the Fed has now said it will allow inflation to run above its 2% target for “some time” to make up for time spent below target. Despite the anticipated enormous snapback in economic growth, we believe the Fed will leave interest rates unchanged, and to add stimulus by continuing quantitative easing through the end of 2021.
Georgia delivers the “blue wave”. Democrats were able to flip both U.S. Senate seats in Georgia’s special elections, giving Democrats control of the Senate by virtue of having 50 seats plus the vote of Vice President Kamala Harris to break ties. We expect further economic relief, including another stimulus check, as well as an extension and possible increase of the special unemployment payments, which are set to expire in mid-March. An infrastructure plan with a focus on renewable energy and green initiatives is also likely.
We also expect some tax increases, most likely targeting corporations, high income earners, and possibly capital gains and dividends. A closely divided Senate probably means that some of the more progressive, anti-business policies will not get through as centrist Democrats are unlikely to support them in the Senate. In addition, the Democrats’ majority in the U.S. House of Representatives has narrowed, which also could influence more progressive legislation.
Mixed results for asset classes at year’s end. Despite the tremendous challenges that 2020 brought, the market has seen a resurgence in risk appetite. Led by growth and large cap names, the S&P 500 Index posted a 16% return for the year. The small cap and cyclical side of the market saw a strong resurgence as the year drew to a close. In the last week of the year the S&P 500 Index, NASDAQ Composite and Russell 2000 Index posted all-time highs. However, corporate earnings presently are in a weak spot, with S&P 500 Index earnings for 2020 expected to be down close to 20%. Earnings were even more sharply impacted in the small cap and cyclical sectors of the market.
So why are we seeing these new highwater marks? We believe this shows the market has a risk-on attitude that we will get through this air pocket of economic activity caused by the latest virus resurgence, as COVID-19 vaccinations begin globally. The market is looking through to the 2021 recovery, expecting earnings to bounce back to the 2019 run rate and beyond. While uncertainty remains high, as evidenced by the still-elevated level of the CBOE Volatility Index, we are moving toward greater certainty and visibility as vaccine approvals and vaccination programs continue. In addition, the market has strong tailwinds due to fiscal and monetary policy that is set to remain in place.
From Bitcoin to special-purpose acquisition companies (SPACs), there are signs of froth in the market. However, with the broad market trading at 21 times forward earnings, we do not see this as a bubble. Some sectors of the market do have valuations that are quite demanding, and we would certainly expect some rebalancing of valuations. This does not undermine the broader underlying fundamentals of the market, which we believe is very investable at its current earnings multiple.
We believe equities are well positioned, especially versus the fixed income arena. Outside of China, negative real rates are the rule rather than the exception especially in developed markets. As a result, we believe it is prudent to be careful about fixed income instruments, especially those with long duration. However, you don’t need to “own the market” but pick your spots, which is the point of active management. Starting with an S&P 500 Index earnings yield of 4%, you can either buy less aggressively valued stocks or you can pick higher quality business models where the earnings yield is not higher, but confidence in the certainty and duration of that yield is higher.
From China to the U.S., we see internet and social media giants increasingly becoming a target of regulators. While we believe this type of attention is not likely to go away anytime soon, the anti-trust scrutiny is more reflective of strong business models and market power. The key to investing where there is increased regulatory scrutiny is having confidence in the management team to be effective in navigating and maintaining a company’s social license to operate.
In summary, while 2020 was a wild ride we did end up with 16% returns from the S&P 500 Index versus the long-term average of 8%. While we think this means there has been some pull-forward of returns, we still find the equity market appealing. While there are some excesses in the market, these excesses are creating opportunities which calls for active management.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Jan. 5, 2021, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The S&P 500® Index is a float-adjusted market capitalization weighted index that measures the large-capitalization of the U.S. equity market. The NASDAQ Composite is a stock market index that includes almost all stocks listed on the Nasdaq stock market. The Russell 2000® Index is a float-adjusted market capitalization weighted index that measures the performance of the small-cap segment of the US equity universe. The Russell 2000® Index is a subset of the Russell 3000® and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. It is not possible to invest directly in an index.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.