2020 | Looking Back
Looking back at our expectations going into 2020 reminds one of the words of former defense secretary, Donald Rumsfeld:
“[There] are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tends to be the difficult ones.”
2020 was the year of the “unknown unknowns”. Our top concerns going into the year were of stretched US equity market valuations (we had just come off a year where equity markets were up over 16% with no earnings growth for the year) and concerns about fixed income in the low-rate environment towards the end of 2019. Most of the concerns we brought into 2020 were overwhelmed by the pandemic and resulting economic shutdown, along with the historic coordinated global monetary and fiscal response. For the past decade, markets have continually demonstrated their dependency on accommodative monetary policy—a trend we have often highlighted with ongoing concerns about the capacity of monetary tools to deal with the next true crisis. So, entering this year with a significant quantitative program already in place, market participants turned to Congress for fiscal stimulus in response to the pandemic—much of it funneled through the Fed to support markets. As a result, the Federal Reserve will end this year with roughly $17 trillion in assets on its balance sheet (the largest balance in history) and the US government is expected to run a deficit for the 2020 fiscal year in excess of $3 trillion.
On the upside, this intervention has helped spur an economic recovery, maintain the normal functioning of corporate debt markets, and fueled equity markets to post positive returns in a year where corporate earnings are expected to fall approximately 8% from 2019.
Despite all of this, many families, small business owners, and sectors have not recovered yet, as shown by the following chart:
This recovery has been incredibly disparate with significant winners and losers, both within equity markets as well as within the consumer and labor market economies.
2021 | The Road Ahead
Many of the concerns we carried into 2020 will certainly carry over into our view related to the long-term prospects for investors once markets eventually normalize to a post-pandemic period. We expect the economic story of 2021 to be focused on when the economy will start to reopen, how long it will take for the economy to get back to normal, and the magnitude of stimulus provided until that happens. Global GDP growth estimates look strong, especially for non-US economies:
While Q4 earnings are expected to be moderate, the first quarter of 2021 is expected to have strong earnings growth. While it is possible we may see some additional lockdowns imposed in various countries across the world in response to spikes in virus cases associated with the holiday season, we expect encouraging vaccine news and additional stimulus to drive equity market performance early in the year. We are generally bullish on equities for the first half of 2021. In the latter half of the year, we think markets will need to see real benefits from vaccines and a demonstrated growth in corporate earnings.
As is true whenever one puts together an outlook, there are going to be risks that could put us off track from our expectations. Currently, chief among those risks is an ineffective vaccine distribution effort that pushes economic normalization to later-2021 or early-2022, uncertainty in commercial real estate sector, and the possibility of surprising inflation numbers. We will monitor the agenda of the new administration and possible changes to corporate and personal taxes, long-term gains rates, infrastructure spending, anti-trust enforcement, and alternative energy. As always, the biggest risks will tend to be the “unknown unknowns”.
During the previous quarter, we continued to re-risk as we added stock funds/ETFs to portfolios. The strongest contributors were emerging markets stocks and international small-cap managers. Our tactical manager, JP Morgan Global Allocation Fund, had a very strong year and delivered risk-adjusted returns in excess of their 60/40 benchmark.
In Q4, dividend paying companies presented an attractive buying opportunity. Going forward, as retirees and other income investors search for yield in a low interest rate environment, we think bond investors will look to companies with strong balance sheets and the ability to grow dividends for income. We added iShares Core Dividend ETF because of its low fees, broad diversification in US value stocks, and attractive yield.
We have increased our weighting to small-cap stocks by adding Nuveen ESG Small Cap ETF. While mega-cap stocks have dominated the headlines for 2020, we anticipate a rotation to small-cap companies that have a history of leading in economic expansions. This ETF has low fees, owns over 650 different stocks, and has an attractive yield.
We also added ARK Innovation ETF to portfolios in October. Cathie Wood, the portfolio manager and CIO at ARK Invest, has built an impressive career identifying disruptive companies and new technologies. She focuses on blockchain, artificial intelligence, biotech, energy storage, fintech, and robotics. Even with limited FANG and mega-cap stock exposure, this strategy continues to provide attractive returns.
In the hedged equity, customized structured notes continue to provide attractive risk/reward outcomes:
- The 15-month note benchmarked to the Australian stock index outperformed in a down market. Note was down -6.01%, while the index was down -10.71%.
- The 13-month note benchmarked to the S&P500 was up +14.3%, while the index finished up +16.44%.
- The 15-month note benchmarked to the S&P500 was up +16.50%, while the index was up +26.40%.
- The 32-month Russell 2000 note was up +31.94%, while the index was up +24.57%.
As always, we are grateful for your continued trust. We wish you and your family a safe and fruitful New Year.