The fourth quarter of 2020 was a bustle of news and activity as progress was made on COVID vaccines, America voted in a presidential election and stimulus talks swirled. Below is a brief summary of what happened in financial markets between October 1 and December 31, 2020 followed by some perspective on markets in both the present and the future.
Stock market strength continued through the fourth quarter as all major style and size factors finished in positive double-digit territory. The S&P 500 rallied 12.2% for the quarter and the Russell 3000 finished up 14.7%. International markets outpaced the U.S. in Q4 with the MSCI EAFE up 16.8% and the MSCI Emerging Market Index up 19.5%. In relatively uncharacteristic fashion given the trend of the last several years, value stocks outpaced growth stocks on a quarterly basis.
For the year, performance was positive across the size and style spectrum, but the dispersion was broad. The S&P 500 closed 2020 with a 18.4% gain and the Russell 3000 came in at positive 20.9%. Despite dollar weakness since March, U.S. indices outperformed their international counterparts as the MSCI EAFE and MSCI Emerging Market indices gained 8.5% and 18.1%, respectively. Along the style spectrum, value stocks’ fourth quarter rally was not enough to close the 2020 performance gap as the Russell 1000 Value lagged the Russell 1000 Growth by roughly 36 percentage points.
In fixed income markets, the yield curve steepened and corporate spreads tightened over the quarter. High-yield bonds and global bonds outperformed the core U.S. government and credit market. On a yearly basis, corporate spreads finished tighter despite a March blowout as the yield curve steepened and shifted down with rate cuts. Relevant fixed income indices all finished positive for 2020 with global bonds performing best.
With a flurry of factors affecting market prices, it becomes difficult to get a clear picture of where markets stand, what is “priced in” to present valuations, and the key points of tension amongst market participants. While this factor overload is omnipresent, its nature seems especially pronounced as investors head into 2021.
Views for the coming year are broadly dispersed as evidenced by 1) differing calls amongst financial pundits, 2) a significant absence of corporate earnings guidance and 3) the valuation gap that exists within the stock market.
- Some Wall Street forecasters believe stocks to be underpriced heading into 2021 and expect that stimulus, which first flew into investable assets, will now flock to the economy driving both corporate earnings and stock prices higher (source). On the contrary, headlines have not been void of pessimism as others voice concerns about the government’s short-term fixes not being enough to cure long-standing structural economic inequalities (source).
- Many companies across industries have been hesitant to provide their usual earnings forecasts. Typically, about 285 of the S&P 500 companies offer earnings guidance, but that declined during the uncertainty of COVID. While predictability has grown since the height of the pandemic when only 101 companies offered guidance, during the Q3 earnings season this improved to only 138 (source).
- For some companies, valuations have sky rocketed. Center stage is the new issue market where 19 initial public offerings (IPOs) doubled in price on their first day of trading in 2020. By comparison, that happened only 27 times in the 19 years since the end of the tech bubble (source). Further, some long-tenured members of the S&P 500 have also experienced drastic multiple expansion. JPMorgan notes the valuation dispersion between the 20th and 80th percentile of S&P 500 stocks is currently 21.6x, significantly above the 25-year average of 10.8x (source). This provides clear evidence that expectations for companies around the world are meaningfully more diverse than any time in recent history.
While it is important to understand the prevalence of this tension in the market, it is also vital to understand what is driving the tension and what outcomes will eventually drive market prices. Vaccine take-up, consumer behavior and policy measures by the government and the Federal Reserve are likely to be these key drivers.
It should come as no surprise that much of the economic success of 2021 hinges on the successful distribution of the COVID-19 vaccine (both from a logistics and a population receptiveness standpoint). Presently, both vaccines with emergency use authorization in the U.S. need to be kept very cold through the entire logistic network. This has made distribution of the vaccines very difficult, resulting in vaccine loss of already limited doses.
Despite the possibility of lower effectiveness, successful global authorization of the AstraZeneca or Johnson & Johnson vaccines may be game changers as neither requires cold storage and both have other logistical benefits.
With vaccines deployed, it will be up to global health officials and pharmaceuticals companies to properly educate populations on the necessity of the vaccine.
Upon reaching a level of herd immunity, consumer behavior will be the next driver of corporate earnings and economic recovery. Even after the risk of COVID-19 transmission has been reduced, it remains to be seen how long it will take consumers to feel confident and safe enough to return to their pre-pandemic routines. Some industries may be lost forever while others will likely experience a drastic burst of catch-up activity as people indulge in their return to social interaction.
Finally, the coordinated strategies of governments and central banks around the world will be an additional driver. Emerging from robust fiscal stimulus and zero-interest monetary policies will represent a new age of policy considerations and frameworks. As spending returns and inflation potentially burgeons, the ideological shifts by these two groups will be monitored closely and can affect asset prices in the nearer-term.
In this time of heightened uncertainty and broad corporate performance, we believe it to be evermore important to focus on investing with a diligent and stable process. Chasing recent returns, speculating in assets and making spur-of-the-moment decisions is rarely rewarded over the long-term.
We believe our disciplined process will continue to add value into the future regardless of short-term market moves. With a complementary focus on both active and index portfolio management, we are well positioned to handle this uniquely tensioned and uncertain future.
As always, we thank you for your trust and look forward to our meetings with you in the near future.