2020 will go down in history as a year we all wish we could forget, but never will. The unprecedented coronavirus pandemic changed everything. While the economic and earnings recession was short but deep, the humanitarian crisis remains devastating. The U.S. alone has already seen more than 15 million cases (over 75 million globally) and 300,000 fatalities (over 1.5 million globally). Around the world, global GDP has declined by $10 trillion, and in April alone more workers lost their jobs than gained jobs in the 10 years following the Great Recession. The pandemic has also left what may be permanent scars on many service industries.
After making an all-time high on February 19, stocks collapsed 35% by March 23, making it the quickest and sharpest bear market in modern history. From there, thanks to extremely aggressive global monetary and a number of fiscal “whatever it takes” policy responses, stocks climbed nearly 70%, resulting in yet another double-digit annual percentage gain for the S&P 500 Index. For the first two-thirds of the year, U.S., large-cap and growth stocks outperformed non-U.S., small-cap and value stocks. For the rest of the year, however, the latter group outperformed. Political division was rampant in 2020, leading to a bitter November election with Joe Biden being elected over incumbent Donald Trump. Perhaps the year’s biggest miracle was the development of Covid-19 vaccines in just a few months, compared to a more normal period of years.
The world improves, but do markets already know? Investors have grown increasingly bullish as the market has reached new highs, and extreme sentiment readings could represent a near-term risk for equities. But, in general, as the population gets inoculated and large parts of the economy reopen, a virtuous cycle of increasing consumer and business confidence should boost GDP and provide for strong corporate profit growth.
This calls for an environment where stock market performance will no longer be driven by P/E valuations, but instead by earnings. Economic and earnings growth will undoubtedly be strong over the next year or two. The passing of the leadership baton will likely be an uneven shift from growth, big and U.S. stocks to value, small and non-U.S. stocks. Perhaps the biggest near-term risk to the financial markets is a larger-than-anticipated increase in inflation and interest rates. Will the debt/deficit picture for the U.S. cause problems for the dollar? And how will a Biden administration deal with an ambitious China? This is a big question in our view. Hopefully, earnings growth from a continued reopening of the economy powered by vaccinations will keep stocks rising in 2021.
In our October Investment Outlook, we introduced TINA (there is no alternative) argument for stocks: It’s hard to make the case that stocks aren’t the better option when the dividend yield of the S&P 500 is higher than long-term government bond yields. In other words, equities are still the only game in town.