“When everything seems to be going against you, remember that the airplane takes off against the wind, not with it.”
— Henry Ford
The year 2020 will surely be remembered as a very bleak chapter in human history. The coronavirus pandemic took the world by surprise and by storm, inflicting enormous suffering in human and economic terms.
And yet, as I reflect on the past year, I’m struck by the strength and resilience of the human spirit. At their own peril, health care providers and other essential workers soldiered on. Businesses large and small pivoted in countless ways to navigate a changed world. Researchers mobilized to develop COVID-19 vaccines at historic speed. And the U.S. and other governments rolled out economic stimulus programs that, in some cases, rivaled or exceeded those of the global financial crisis in scope.
Like powerful jet engines, such efforts helped lift the global economy out of a deep hole and put it on the path to recovery. The U.S. stock market, a forward-looking indicator, began to signal a recovery even before some states had lifted the stringent lockdown measures of last spring. Much to the surprise of many, the market finished 2020 with a return in the high teens, as measured by the S&P 500 index.
The market’s dramatic rally in recent months has many investors wondering how much upside is left. As we turn the page on an extraordinary year, it seems fitting to dispense with our usual format for market commentaries in favor of one that seeks to address that question and others that are top of mind for many investors. To do so, we draw heavily from the insights of the Goldman Sachs Investment Strategy Group (ISG) 2021 Outlook, aptly titled US Resilient.
The S&P 500 hit all-time highs in late 2020. Can this rally continue?
In short, yes. Despite near-term challenges, we believe the U.S. is still in the early stages of a multi-year recovery that will provide a tailwind for corporate earnings and, in turn, stock prices. ISG expects earnings for S&P 500 companies to grow by 24-27% per share this year, according to its 2021 Outlook, which is based on data and analyses through Dec. 31, 2020.
One of the key reasons that the U.S. economy regained its footing relatively quickly — and is likely to continue growing — is because of the unique nature of the COVID-19 crisis. The pandemic is what economists might call an exogenous shock, in other words one coming from outside the economy, such as a natural disaster. By contrast, the global financial crisis was triggered by an endogenous (or internal) economic shock, in the form of financial imbalances (notably in the housing sector) that took time to work off.
The swift and forceful actions of U.S. lawmakers and the Federal Reserve have also helped mitigate the damage to corporate and household balance sheets that typically slows post-recession recoveries, as noted by ISG in its 2021 Outlook. Many policymakers remember all too well the languid recovery that followed the global financial crisis.
Among major central banks, the Fed has been especially aggressive when it comes to cutting interest rates to keep credit flowing to households and businesses. In November 2020, the central bank decided to hold the target range for the federal funds rate at its effective floor of 0.00%-0.25%. We expect the U.S. economy to continue to benefit from very accommodative monetary policy in the year ahead.
Source: Investment Strategy Group, Bloomberg, Haver Analytics.
It’s also worth noting that — despite the recent stalemate in Congress over COVID-19 relief — the federal government has provided an unusually large amount of support (in relative and absolute terms) to struggling consumers and businesses:
The new Biden administration has proposed $1.9 trillion in new fiscal relief measures, although the proposal may face hurdles in Congress. (For more insight on how the new presidential administration could affect markets, industries and economies, watch this video featuring several of my Goldman Sachs colleagues.)
To be sure, President Biden takes office at a time of enormous challenges for the country. Yet we don’t expect near-term challenges to derail the current economic recovery: According to its 2021 Outlook, ISG expects the U.S. economy to grow by 5.4% this year, after contracting by an estimated -3.5% in 2020. The linchpin of ISG’s optimistic forecast is the high likelihood that widespread vaccinations bring the pandemic under control during the first half of this year.
What are the implications for equity-market investors? Against an anticipated favorable economic backdrop, ISG expects a base case total return of 8% for U.S. equities and 8.6% for global equities, according to its Outlook. ISG expects equities to outperform cash and bonds. (More on the outlook for global growth and bonds below.)
Are today’s high stock market valuations justified?
While the valuations of S&P 500 companies appear high on an absolute basis relative to history, it’s important to consider them in the context of today’s macroeconomic climate, as ISG notes in its Outlook.
Since 1996, the U.S. has been in a period of low and stable inflation. Because such periods give investors greater confidence in the future cash flows of companies, they have supported valuations that are 35% above the post-World War II median. Today’s interest rates are considerably lower than those during similar past periods and have room to rise before becoming a headwind for stocks, according to ISG’s Outlook.
How might U.S. stock market dynamics shift this year?
The market’s robust return in 2020 belied a wide dispersion in performance among value and growth stocks. In 2020, the Russell 1000 Value index underperformed its growth counterpart by an eye-popping 36%, according to ISG and Bloomberg.
Value stocks are generally cyclical in nature; in other words, they tend to do better when growth is on the upswing. Growth stocks are generally shares of companies whose earnings are growing faster than the overall market. They tend to perform well during periods of economic uncertainty because many investors are willing to pay a premium (as measured by metrics like price-to-earnings or price-to-book value) for shares of companies that can perform relatively well under such conditions.
Technology, a quintessential growth sector, led the market higher for much of 2020, gaining nearly 44% by year’s end, according to FactSet.
However, late last year, value stocks began to stage a comeback amid optimism over the federal approval of COVID-19 vaccines. That trend could gain momentum this year, if, as ISG projects, vaccines are more broadly administered in the coming months and the recovery gains traction. Under such conditions, we may also see a continued rebound in small-company stocks, which lagged large-company stocks for much of 2020.
What’s your outlook for global economic growth this year?
We expect global growth — which contracted by an estimated -4.1% in 2020 — to be positive, to the tune of 5.3%, according to ISG’s Outlook.
In the U.S. and other developed-market countries, the recovery that began last spring appears to have lost momentum lately because of the resurgence in COVID-19 cases and related containment measures. But we expect economic activity to pick up as these countries begin to surmount the operational challenges of mass vaccinations in the coming months. By year’s end, the hard-hit Eurozone and U.K are expected to grow by 4.6% and 5.2%, respectively, according to ISG.
For full-year 2021, ISG expects emerging-market economies to grow (on the whole) by nearly 6%, after suffering their worst performance in decades last year. China, the pandemic’s initial epicenter and world’s second-largest economy, is expected to grow by 7.5%, up from an estimated 2% in 2020, as per ISG.
That said, many countries are likely to lag the U.S. in their recovery. In fact, ISG expects the U.S. economy to outperform other developed-market regions this year.
In my view, the U.S. appears to be bouncing back more quickly than many other countries because of the government’s ability to mount a stronger response in terms of stimulus. And, despite recent challenges in hard-hit U.S. states, the country’s infrastructure, including its health care system, has held up relatively well under the strain of this crisis.
What are the risks to global growth and financial markets?
One of the greatest risks is a worsening of the pandemic. As I’ve noted in past commentaries, the path of the economic recovery will be shaped largely by how we handle the underlying cause of this crisis.
Health experts, according to ISG’s Outlook, expected the U.S. to reach peak levels of infection in early January 2021 and peak fatalities a few weeks later. But it may take longer for the country to turn a corner because the vaccine rollout has been slower than expected and Americans have generally grown more lax about following social-distancing guidelines. In addition, new and potentially more contagious variants of the novel coronavirus have been detected at home and abroad. It remains to be seen whether current and forthcoming vaccines provide immunity to these variants, but scientists are generally optimistic about this prospect.
Source: Investment Strategy Group, US CDC (as of 5 January 2021), Our World In Data (as of 6 January 2021)
We continue to recommend that clients stay invested despite the near-term challenges posed by the lingering pandemic. As ISG notes, exogenous shocks like pandemics, tsunamis and wars are inevitable. But since they can’t be predicted, it’s best to ride them out.
For evidence of this, we need only look back to 2020, when the U.S. stock market ended the year with a remarkable double-digit gain despite the fact that reported COVID-19 infections surged to about 20 million domestically; the pandemic’s U.S. death toll climbed to an unthinkable 345,000; the U.S. economy shrank; S&P 500 earnings fell by an estimated 17%; and some 11 million Americans remained unemployed at year’s end.
What’s your outlook for the bond market in 2021?
Several factors are likely to weigh on fixed-income returns, particularly government bonds:
Despite our lower return expectations for bonds, we expect them to continue to play an important role in dampening portfolio volatility.
Last year, we saw some stark examples of the traditional inverse relationship between stocks and bonds. At one point during the tumultuous first quarter of 2020, the 10-year Treasury posted a one-month, rolling return of more than 10% — a performance not seen since the financial crisis, according to ISG’s Outlook. By the end of 2020, the 10-year note had delivered a double-digit gain. Indeed, every major fixed-income class had positive, inflation-beating returns last year, as reported by ISG.
Much like an airplane during takeoff, the markets and the economy are bound to experience some turbulence in 2021 as they head toward a cruising altitude. Last year provided a stark reminder that investors who are able to ride out volatility and stay focused on their long-term goals are often rewarded.
As always, you don’t need to go it alone. Reach out to your financial adviser if you have additional questions about this year’s outlook and how to position your portfolio to meet your long-term goals. That's what they’re there for.
Happy New Year!
Invest well and stay healthy,
Kara Murphy, CFA
Chief Investment Officer
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S&P 500 Index: A broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.
Russell 2000 Index: This index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; the index serves as a benchmark for small-cap U.S. stocks.
MSCI Europe, Australasia, and Far East (EAFE) Index: This index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.
MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009, the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Bloomberg Barclays U.S. Aggregate Bond Index: This is a market capitalization weighted bond index of investment-grade, USD-denominated fixed-income securities.
U.S. High Yield Corporate: The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
U.S. Investment Grade Corporate: The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility, and financial issuers.
Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated, long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS) to offer an efficient investment tool to capture the breadth, depth, and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes and are considered during the annual review process.
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