As 2020 began and COVID-19 swept across the globe, it was hard to imagine the magnitude at which the impact of the disease would be felt. But as the actions that needed to be taken to slow the spread of the virus became more drastic and the impact of those actions became more apparent, the stock market responded with the swiftest bear market on record accompanied by a recovery that was just as swift. Initial economic impairment was minimized by immediate and decisive monetary and fiscal actions, allowing for an economic rebound in the third quarter. The upbeat news continued in the fourth quarter as optimism surrounding a vaccine grew amidst promising results from multiple vaccine candidates. We closed out the final month of the year with two vaccine approvals in the U.S., initial deployment of several vaccines across the globe, and a $900 billion stimulus package.
So what are we at JGP Wealth looking at as we start to consider portfolio positioning for the New Year?
If 2020 was dubbed “The Year of the Virus,” then 2021 is “The Year of the Vaccine.” As we await more vaccine approvals, most estimates put the U.S. at reaching herd immunity in mid-to late-2021, bringing with it a presumed rebound in consumer spending and economic activity. Additionally, with the Democratic Party taking control of the White House and Congress, we expect further stimulus measures to be passed in the first quarter, including supplemental income checks to individuals. The idea of a return to “normalcy” and additional stimulus for individuals has pushed investor and market sentiment to extreme optimism. These actions also mean, over the medium term, we will need to keep an eye on inflation, as it could start to creep in sooner than initially anticipated.
By most measures, S&P 500 Index valuations could be considered stretched at current levels. A significant part of this can be explained by the concentration and bidding up of the top five names of the index. These mega cap companies – Facebook, Apple, Amazon, Microsoft, Google – thrived in the stay-at-home environment and contributed significantly to the recovery of the market. As of 12/31/2020, these five companies had grown to an inordinate 22% of the market capitalization of the index and returned 49%, while the remaining 95% of the companies in the index returned 9%.
Another important thing to remember is that the stock market is considered a leading indicator. This means it prices in expectations of future corporate and economic changes. With the economic downturn not being as severe or as prolonged as originally expected and with large corporations faring better than anticipated, a rebound in corporate earnings and economic activity has largely already been priced in to the markets. So, even though earnings may recover quickly throughout 2021, we may see more subdued market performance, assuming we pulled forward much of that performance from 2021 into 2020.
While some may argue that those few, concentrated mega cap stocks may be overbought, it’s clear to us the dispersion of the valuations of stocks in the S&P 500 is wide, indicating there is plenty of opportunity for strong performers to surface in other areas of the market. As we move out of recessionary times and into a recovery, opportunities may arise as we see investors rotate out of defensive sectors and into more cyclical areas of the market. Additionally, those companies that benefitted from the stay-at-home mandates may find it hard to replicate or sustain those earnings as businesses are allowed to reopen and society starts to return to normal.
Finally, and perhaps most importantly, monetary policy remains accommodative, with the Federal Reserve committing to keeping interest rates and bond purchases at their current levels for the foreseeable future. While low interest rates typically provide a cap on bond yields they should continue to act as a catalyst for growth and support economic, corporate, and stock market investment.
Other areas we will be watching will be any policy changes that may be enacted by President-elect Biden and his administration, potential changes in our geopolitical relationships, and whether or not the recently developed COVID-19 vaccines can be used against the new strain of the virus that has recently surfaced.
Despite the challenges 2020 brought us, 2021 does appear to be moving us in a more positive direction. The economy is continuing to improve, vaccine distribution is providing hope we will soon move past the virus, and both monetary and fiscal policies are maintaining their supportive measures. While we may still experience some short-term challenges and volatility, we believe these risks can be managed and mitigated by maintaining appropriate portfolio investments and diversification.
At JGP, we appreciate and respect the trust you put in us every day as we strive to help you live the life you want. As we kick off 2021, we thank you for your continued support and we look forward to a prosperous New Year!
Shannon Jones, CFA, CFP®