What a year. A deadly global pandemic. Emotional protests and civil unrest. A cantankerous, disputed election. 2020 was a year most would like to forget. However, despite all of the “real world” challenges, financial markets kept chugging along with stocks and bonds delivering healthy returns to investors. A one-two combination of swift Federal Reserve monetary response and the government’s fiscal stimulus shepherded the markets through the darkest days of 2020’s Covid-induced crisis. The contrast was stark between the doom and gloom of March and investor euphoria driven by optimism on a vaccine and an anticipated economic reopening in November and December. In the end, financial markets in 2020 looked rather typical, if not robust. The “real world” on the other hand… well, it was anything but normal.
If you are like us, the dawn of a new year brings a sense of optimism and excitement. Many would agree these feelings are only magnified following the chaotic events of 2020. Unfortunately, the calendar is arbitrary. It is simply a way for us to keep track of time. The “real world” doesn’t care that it’s 2021. The challenges from last year are still very much with us. The pandemic continues raging, with the U.S. reporting record deaths on a daily basis. An extraordinary episode of civil unrest was front and center at the US Capitol recently. The presidential election is over, and what appears to be a fractured country is left in its wake. And the financial markets? Almost bewilderingly, like in 2020, they keep pushing forward. The calendar year has changed, but nearly everything else remains the same – or does it?
Perhaps the single most important difference between this year and last is that Covid-19 vaccines are now being deployed. Despite some initial distribution hiccups, it is only a matter of time before everyone who wants the vaccine receives it. An immunized population means the economy can reopen and people can resume their everyday lives. We said last April that a vaccine was the only sure-fire solution to the Covid-19 economic problem. The vaccine is now here, in record time (as an aside, we postulate the speedy development of several Covid-19 vaccines will be recognized in the history books as a modern scientific miracle).
Of course, as vital as it is, the vaccine is not the only factor influencing the future path of the economy. The incoming Biden administration, paired with Democrats now controlling Congress, is expected to boost government spending (think infrastructure) and pursue additional stimulus to the tune of $2,000 per qualifying person. Pent-up consumer demand, Uncle Sam opening the checkbook, and hard cash hitting the pockets of individuals are the perfect ingredients to get the economy cooking. Financial markets are showing early indications of optimism on this front. Cyclical stocks – financials, energy, materials – are coming to life. Interest rates are ticking-up. Markets are beginning to believe the economy is on the mend.
The picture isn’t all rosy, however. Anytime something really gets cooking, there’s the possibility of overheating. A question some investors are already pondering is whether Fed intervention and government spending could spur inflation. If inflation materializes, the Fed could be forced into rate hikes. Inflation and rising rates would be a poor recipe for financial markets at this juncture.
Another consideration is current stock valuations and pockets of froth in the market. Some tech stocks and more speculative companies sport nosebleed valuations. There have been comparisons to 1999 and the excessive valuations of the dotcom bubble. While we wouldn’t go that far, there is no question animal spirits are driving overexuberance in some corners. The bottom line is that stocks, particularly mega-cap U.S. stocks, have run hard. Valuations are on the higher end – not worryingly so, but worth keeping an eye on.
Finally, going back to the “real world”, there are still significant concerns regarding the devastation across small businesses and the current level of unemployment. Certainly, the reopening of the economy and substantial government assistance will help, but there are huge question marks surrounding the lasting impact of the pandemic. Several trends were accelerated over the past year, particularly pertaining to the use of technology and how businesses operate. Last quarter, we had discussed the “K-shaped” recovery and the “haves and have nots”. Areas such as online retail have greatly benefited, while smaller brick-and-mortar retailers have suffered. Nobody knows exactly what a post-pandemic economy will look like.
So, Where Does This Leave Us?
Predicting financial markets is always difficult, if not impossible. 2020 offered the clearest example yet of the difficulty of reading tea leaves – whether economically, politically, or otherwise. Potential market drivers in 2021 include the timing of fully reopening the economy, government spending and stimulus, the Biden administration’s impact via other policy pursuits such as tax hikes or tech regulation, and whether inflation rears its ugly head. Perhaps the biggest wild card remains the Federal Reserve, although they have given every indication of remaining accommodative and maintaining a “zero interest rate” policy. If that changes, all market bets are off.
While 2021 has begun feeling like “more of the same”, meaningful changes are occurring under the surface – as is typically the case. The nature of financial markets is uncertainty. As a new year dawns, we believe this is the perfect time for investors to refocus on what they can control with certainty – namely diversification, low investment costs, tax efficiency, and savings. These are pillars of The ETF Store’s approach, regardless of market, economic, or political conditions.
Happy New Year, and we look forward to a more positive 2021!