Never underestimating humanity’s collective power to overcome adversity will be a significant takeaway from the unforgettable year of 2020. As we are hopefully nearing the final stages of the pandemic, we think it is important to step back and recognize its lessons. The pandemic has reminded us of our individual and collective fragility as well as the formidable power of nature to upend the comfortable lives we have built. The year also spotlighted that the people who are truly critical to our survival and happiness are often overlooked, ignored, or even disrespected. Finally, it has reminded us of the crucial role government can play in national crises, including the powerful, painful consequences when it comes up short.
At the same time, 2020 has been inspirational. We have seen frontline healthcare workers risk their lives day to day. In addition, the term ‘essential worker” has been extended to include an array of normal everyday professions. We witnessed the triumph of science and technology in developing several vaccines in record time. In the end, many of us have gotten a chance to level set our relationships with family, reconnect with old friends virtually, and appreciate what really matters in life. We are sure that the pandemic has caused unbearable losses for many of you and we offer you our heartfelt sympathies. We urge you to take solace in the great memories with all loved ones lost.
2020 in Retrospect
The COVID-19 pandemic created a shock to the system and forced our well positioned economy into the greatest economic contraction in generations. Due to the deliberate shut down of the economy, the nadir of the economic fallout occurred in the 2nd quarter with GDP contracting at an annual rate of -32.9%. This was the sharpest decline in modern American history and nearly three times as sharp as the previous record of -10% in 1958.
As the economy reopened, activity rebounded nicely in the 3rd quarter with U.S. GDP increasing at an annual rate of 33.4%. However, the damage was done as we witnessed recessions around the world, disrupted supply chains and policymakers in every corner of the globe vigilant in supporting financial markets and their economies. The forced shutdown drove joblessness to levels not seen since the Great Depression. For the year, 9.37 million jobs were lost exceeding the 5.05 million jobs lost in 2009, in the aftermath of the global financial crisis. While many of the job losses may be permanent, we are optimistic that the rebound in employment will be persistent.
In response to the crisis, we witnessed one of the swiftest and most decisive sets of policy responses ever implemented by central banks and fiscal policymakers. As we mentioned in our Market Update during the early stages of the crisis, our Federal Reserve and Global Policymakers were underwriting financial stability by effectively functioning as a giant commercial bank, with an unlimited ability to expand its balance sheet. By cutting interest rates, expanding asset purchases, and providing a backstop with massive liquidity support measures, central banks were able to ensure that global conditions remained fluid. All told, the level of stimulus applied to keep the U.S. economy flowing was over $3 trillion and growing. This unprecedented level of support aggressively helped stabilize the financial system as we clawed our way through the pandemic.
For the year, the S&P 500 finished up with a total return of 18.40%. It is rare in a given year to have witnessed a bear market drop and a bull market rise. Amazingly, the market fell just under 34% from February 19, 2020 through March 23, 2020 and rose 67.88% from the March low through the end of the year. The declines and gains were uneven, as the quick economic shift from the virus had some industries mostly closing operations (travel, hotels, stores, etc.), while other at-home services and merchandise benefited nicely. The uneven market pushed it to be top heavy with the top ten companies in the S&P 500 driving the yearly performance.
Some segments of the market’s 2020 performance were unnatural to say the least. The sheer level of liquidity crowded out investment into otherwise safe haven securities by pushing bond yields near an all-time low. Many investors continued chasing yield and returns by going much further out on the risk spectrum. The technology sector, SPACs (black check companies), and many of the stay-at-home stocks come to mind here. IPO issuance hit a new record in 2020 with $180 Billion of new companies coming public. This total was double 2019’s total and up from $102 Billion record in 2000.
Other bellwether indices performed well for the year with the DOW up 10.45, the Nasdaq Composite up 44.92%, the small cap Russell 2000 up 19.96%, the MSCI Eafe international index up 7.82%, and the MSCI Emerging market index up 18.69%.
Our initial outlook and themes for 2020 did not totally hit the mark due to the health crisis. We did not avoid a recession, the Fed underwent the most ambitious liquidity campaign ever, and inflation was not a problem in 2020. We envisioned a 10% correction in the stock market during the year with a recovery to double digit gains by year end. That pales in comparison to the bear market decline witnessed, but the markets did however finish up double digits.
Our suggestion that oil prices would recover last year fell short of our prediction. The historic plunge in oil prices was unpredictable and fundamentally irrational. The combination of plunging demand for oil due to the COVID induced economic collapse and the Russia and Saudi Arabia oil price war sent crude oil on a historical plunge. Oil prices took an extraordinary ride to below zero in April due to the huge supply demand imbalance. The damage was severe, but short term, and created an opportunity as oil prices recovered to finish the year above $50 per barrel. We have maintained a position in energy as part of our diversified approach to investing. That discipline was tested, but in the end, staying the course proved to be beneficial.
Outside of the Annus Horribilis due to the virus, the Election of 2020 was one of the primary focuses all year. Last year’s election has polarized an already polarized nation and emotions regarding the election ran wild. At Parrish Capital, we have stressed our politically agnostic bend as it relates to politics. While it is true that politics matter, we have seen this movie before. The market reacts constantly to shifting economic winds more so than shifting politics. President’s priorities and agendas are based on a four-year vision while investors need to have decades-long vision. It is all important to not allow your short-term anxiety to get in the way of your long-term strategy and goals. Making an emotional anxiety-based change today is more likely to be harmful than weathering the potential changes that you fear. Our job is to make sure that perceptions do not overshadow our investment process and to strategically incorporate potential tangible changes into how portfolios are positioned.
Declaring an end to the War
The year 2020 delivered a massive global health crisis and an economic calamity akin to a war, but 2021 promises to offer an end to both. As we head deeper into the new year, our economic and investment outlook remains constructive. Perhaps more importantly, the range of uncertainty around that outlook has been reduced by the U.S. Election results and positive news on several COVID-19 vaccines. We feel upside risk will outweigh downside risk for the year as the economy steadily reopens. The most immediate concern is the lasting damage the virus will cause to the global population and its economy before vaccines bring it to a close.
It is impossible to develop an outlook for the year ahead without first acknowledging the ongoing human and economic war resulting from the pandemic. As we write this, COVID-19 cases, hospitalizations, and deaths are rising daily around the globe. Mandatory business closures in the US and abroad are less severe than during the initial wave last spring. However, for many businesses, activity may never return to normal. We suspect that the economy will not be able to fully rebound until the pandemic has subsided for good, but chances are as we learn to live with the virus, consumers’ economic hesitancy will ease while the immunity gap shrinks.
At the same time, the parts of the global economy that can function during a pandemic are indeed functioning. In fact, many segments are thriving. Global manufacturing has staged a V-shaped recovery, as has the U.S. housing market. We suspect that the consumer’s resilience will continue to be a huge positive for the economy. Household balance sheets have strengthened on average due to sparse spending options and financial aid from the federal government. Savings rates remain unusually high as incomes have risen with the help of global fiscal policy stimulus.
For the year, we believe the U.S. Economy will expand with GDP up 4-5% driven by an unleashing of pent-up demand as the US economy steadily reopens. Incremental fiscal stimulus combined with sustained accommodative monetary policy should also lay the foundation for a resilient recovery. The one large caveat is any major changes in the trajectory of the virus and its effect on the full reopening of the global economy.
Politics as usual
The agenda and potential policies of the new Biden administration continues to be the elephant in the room. With Democrats in control of Congress and the White House, we are somewhat encouraged that monetary policy will not be the only game in town. The growing consensus is that the Biden Administration may foster more predictable domestic policies, smoother trade relations, and additional efforts to help revive economic growth. On the flip-side, a Democrat controlled government will not be entirely friendly to investors given the Biden agenda includes corporate and individual tax increases, heighten regulatory oversight, and ambitious social and economic policies as a Green New Deal, health-care reform, and student loan forgiveness. All of which will drive up deficit spending and potentially inflation, putting the Federal Reserve in a conundrum. The implications are wide but manageable.
The silver lining for the market regarding sweeping change is that the Democrats have neither the political capital nor the votes in Congress. The party holds a slim majority in the House and are just one Democratic defection in the Senate away from losing that majority. This slim majority could mean stronger bipartisan negotiations for the foreseeable future. Our expectations are for vast executive orders earlier on, but a carefully crafted and bipartisan Infrastructure proposal late this year.
Earnings, which we maintain are the foundation of stock prices, had a rough time in 2020. S&P 500 companies including projections for the 4th quarter 2020 produced estimated earnings decline of 14.1%. This was the first double digit annual decline since the financial crisis. Cyclical sectors like Energy, Consumer Discretionary, and Industrials bore the brunt of the earnings collapse.
The stock market was not fazed by the earnings collapse, given the temporary nature of the shock, for many industries. However, many industries had to receive lifelines from the government, or the private sector, because even with the potential to do well on the other side of the pandemic, the short-term cash drain was futile.
2021 is looking very promising with earnings expected to rebound over 25% from a lower base. The expected growth recovery is fairly broad which is a high-quality sign for companies trying to get back to a sense of normalcy. Just as important, revenues are expected to resurge 13.5% for the year.
The meteoric rise in the stock market from the lows and on to new highs has been welcomed by all. However, the valuations for the market appears to be a little stretched. The S&P 500 finished 2020 at a Price to Earnings ratio of 22.15 times forward looking 2021 earnings. As we have pointed out over the years, the long-term average P/E ratio is approximately 16 times earnings. Looking a little further out to 2022, the S&P 500 closed the year at 19 times forward looking 2022 earnings.
On the surface the current valuation is a little frothy but considering the nosebleed valuation of most bonds and other asset classes, we believe many equities have much to offer. Decomposing the S&P 500 down to the highest contributors of said valuations reveals that the excessive valuations are crowded at the top and spread over a concentrated set of firms. In other words, we feel that there are plenty of opportunities to be had amongst market participants.
For 2021, we feel that the market as measured by the S&P 500 will perform near the long-term average of 10%. While strong liquidity and additional stimulus are key factors in our outlook, our primary catalyst is a broadening of market participation which started in the 4th Quarter 2020 into cyclical, value, and out of favor companies.
Our Major Market Themes for 2021
- US Economic Growth rebounds with GDP expansion of 4-5% driven by optimism in regard to improving Covid-19 conditions.
- Infrastructure plan is announced in the 4th Quarter and fierce bi-partisan negotiations roll over into 2022.
- Volatility will reign throughout the year, but the S&P 500 will end up near the historical average.
- Speculative and irresponsible investing in high flying growth stocks falls out of vouge.
- Inflation and interest rates began to rise in the second half of the year.
In closing, we are cautiously optimistic but are looking forward to an outstanding 2021. Thank you for allowing Parrish Capital to be your trusted financial advisor. As a reminder, Financial Planning is an integral part of your long-term financial success. Many investors tend to be reactive in major market events. Always stay prepared. If you have not constructed a financial plan, please reach out to Ryan Moledor at 678.231.7863 or Ryan@ParrishCapital.com.
AS ALWAYS IGNORE THE NOISE, STAY FOCUSED, AND PROSPERITY BE UNTO YOU!!!