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What a year that was! 2020 felt like an amalgamation of 1918, 1968, and 2000, with a bit of 1876 thrown in. The year started with the onset of what will likely be the second-most deadly pandemic since 19181 and ended with the most divisive election any of us have lived through. And, as if that wasn’t enough, we saw that the wounds of racial injustice are still open and painful, and there remains much to be done on that front. It was an ugly year politically and an amazing year scientifically, with Moderna developing its initial vaccine within 48 hours of receiving the SARS-CoV-2 genomic sequence. During all of this, we witnessed one of the most extraordinary market years imaginable.
In the second quarter, economic activity plummeted at an annual rate of 31%, the fastest quarterly decline since 1932, and then rebounded at a 33% annualized rate in Q3. Markets followed suit. In the five weeks after notching an all-time high on February 19th, the S&P 500 fell 34%, reaching its low point on March 23rd. The next three trading sessions saw that same index rebound more than 17% and reclaim its February highwater mark by mid-August, completing the fastest bear market onset and recovery on record. If you went to bed on February 19th and woke up on August 18th, you might be forgiven for having thought nothing interesting had happened in markets while you slept.
Nearly every major equity category posted positive returns for the full year, and most ended the year at or near an all-time high. Bonds did just as we would have hoped, providing ballast during the worst of the downturn. For the year, the Bloomberg Barclay’s U.S. Aggregate Bond index returned 7.5%, with most of that gain accruing during the downturn. Shorter-term high-quality U.S. bonds posted returns of between about 2% and 4% for the year.
However, the big market story of 2020 was the performance of U.S. large growth and technology stocks. Many of these companies, which had already been on a multi-year tear, were uniquely positioned for the COVID-induced work-from-home environment thrust upon us, and their full-year stock performances reflected that fortuitous positioning. While most other investment categories (U.S. value, international, and small caps) effectively languished through August, the tech-heavy NASDAQ soared 33% during those same months. However, that relative superiority would fade considerably in the last four months of the year as hopes rose for an effective vaccine and a return to normalcy.
If tech stocks were the biggest story of the year, the second-biggest story (and perhaps the more relevant one as we look forward) was the late-in-the-year rotation away from U.S. tech/growth stocks and the resurgence of other long-suffering investment categories, including emerging markets, international, and even U.S. value. During just the last quarter of 2020, U.S. small caps soared 31%, emerging markets shot up by 19%, and U.S. large value holdings increased by 16%. The S&P 500, meanwhile, finished up “only” 12% for the quarter. It seems like forever since anything other than U.S. growth has led the pack, but the last quarter suggests that things might be changing. If so, it’s about time.
Every so often, a year comes along that offers a master class in investment principles for the long-term, goal-focused investor, which is likely everyone reading this commentary. I would suggest that 2020 was just such a year. So, what lessons might we take away from last year? I would offer the following:
- Predictions aren’t worth much: Large market moves are often precipitated by events that few, if any, see coming. Last year would be a strong case-in-point. I don’t know of one widely read commentator who had anything like COVID-19 and its impact on his or her 2020 Bingo card. The events that move markets tend to be surprises, and when such surprises appear on the radar, it’s usually unclear just how impactful they will be. That was certainly the case in the early days of the pandemic.
- Markets are very efficient: Securities prices tend to reflect new information, good and bad, very quickly — so quickly, in fact, that it’s hard to profitably outguess, out-trade the market. We saw this vividly last year as markets plummeted more than 30% in less than five weeks, with each day’s headlines suggesting worsening outcomes from the growing pandemic and the related shutdowns. And then, after reaching a nadir on March 23rd (although no one knew at the time that it was the nadir), the S&P 500 rocketed upwards almost 18% in three days on glimmers of hope that better news was to come. That three-day stretch ignited a recovery that moved with and even anticipated yet better news ahead. An investor who panicked out at the point midway down was just as likely, and probably more so, to have missed the record-setting recovery and, perhaps even more costly, locked in their panic-sale losses.
- Knowing when (not) to change your portfolio: And this brings us to an overarching point: unless your goals or timeframes around needing money have changed, sticking with a well-thought-out investment plan is almost always the right thing to do. While we talked with many clients during those scary weeks in March, all of the clients who stayed put were better off for having done so, and the few who made changes were not.
- Don’t mix politics and investment policy: To say this was a bitterly fought election and the most divided electorate in our lifetimes would be the understatement of the year. From many conversations this past year, my sense is that the stronger the political inclinations, the more likely an investor was to conflate political outcomes with expected portfolio returns, which historically has been a mistake and certainly would have been last year.
- Diversification requires patience: And sometimes for much longer than you might think. For the last several years, it has been challenging to be an investor who owned anything other than U.S. large-cap growth holdings. It was like the scene from It’s the Great Pumpkin, Charlie Brown...Lucy: “I got five pieces of candy!” Pigpen: “I got a candy bar!” Charlie Brown: “I got a rock.” Until September, being a diversified investor felt like getting a rock on Halloween. However, the investment landscape seems to be changing. Over the last four months, we’ve seen diversification and the patience it requires begin to pay off, as U.S. small caps, value stocks, and foreign holdings have all sharply outpaced the U.S. large-cap growth sector. We’ll see whether that continues to be the case, but it’s an encouraging sign.
So, what might the year ahead hold, economically and marketwise? I’ll first harken back to the preceding section: if 2020 taught us anything, it’s that humility is in order as predictions are often not worth the paper they are (or aren’t) printed on. That acknowledgment aside, here are a few observations about the economic and investment landscape as it looks today:
- At the moment, we are in this in-between place, caught between slowing economic activity in Q4 and Q1 (due to the sharp uptick in COVID cases) and hope for a much better second half (once vaccines are widely available). While Q3’s pace of economic recovery was meteoric, the expectations for Q4 and probably Q1 are muted, with annualized fourth-quarter growth estimates ranging between 2% and 10%. Expectations are considerably higher for the latter part of 2021. It appears — at least from today’s vantage point — that the basic elements are in place for a gradual but durable recovery as we move into the second half of the year.
- One element supporting the case for a healthy recovery is that Americans in aggregate have been saving a surprisingly large share of their income since the pandemic began due to having fewer service-economy-related options for spending those earnings (e.g., dining, travel, sporting events). In April, for example, the personal savings rate was almost 34% of income. Although that number had dropped to 13% by November, it was still nearly twice the prior year’s 7.5% saving rate. The unusually high savings rate, coupled with pent-up demand, offers the prospect for a sharp rebound in service-related spending later this year as coronavirus-related restrictions are eventually lifted. This may provide an additional boost for corporate profitability during the second half of 2021, especially in the hardest-hit sectors.
- With the Georgia run-off complete, we now know that Democrats will control all three houses for the next two years, with a razor-thin margin in the Senate. While control of all three houses increases the likelihood of a tax hike, it also increases the prospects for additional stimulative/economic relief measures, including the possibility of an infrastructure spending plan. Both of these would likely support shorter-term economic activity, albeit at the cost of longer-term government deficit spending. As I have written in prior commentaries, it’s also worth remembering that presidential administrations have only so much influence over economic activity and even less over market performance. Markets have historically been driven by many exogenous factors, over which an administration often has little-to-no control.
- Historically, economic recoveries have favored more cyclical sectors at the expense of growthier sectors. We have seen indications that this is already happening and has been underway throughout the fourth quarter. As each wave of positive vaccine news was announced during December, the growth-heavy NASDAQ fell, while more cyclical holdings and other long-suffering categories surged. This was reflected in the strong performance of U.S. value and small-cap holdings and internationals and emerging markets, all of which have higher cyclical sensitivity than growth stocks.
- Lastly, the weakening U.S. dollar has further added to the strong performance of international and emerging market holdings over the last several months. Should the dollar’s trend continue, this would be a continuing boost for non-U.S.-dollar-denominated holdings, including international and emerging market stocks.
So, many of the building blocks appear to be in place for a continuing recovery as we move into 2021. This year will undoubtedly be subject to the trade-winds of global affairs and the inevitable surprises, both positive and negative, that await us. However, the baseline expectation for growth in the global economy and the companies that comprise it has historically been a good bet. This is perhaps even more so the case in the aftermath of last year’s 3.6% global contraction.
While I know that 2020 was a challenging year across the globe and that this one has gotten off to a rocky start, let us hope that a non-election year — and one with a receding pandemic as vaccinations are more widely available — will bring a better and brighter year for all of us. I wish you and those close to you a 2021 filled with much health, hope, and happiness. As always, we are grateful for the opportunity to be of service, and please let me know if there is anything we can do for you.
1. The HIV/AIDS epidemic is estimated to have killed 35 million since it began in 1981. The 1957-8 Influenza Pandemic and the 1968-70 Hong Kong flu pandemic are each estimated to have killed between 1 and 4 million.