2020 Markets Explained & 2021 Preview, Ep. 15

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In this episode of Solid Financial Advice, Ryan Hughes discusses the factors behind the 2020 market performance and a preview of 2021.

Between COVID, Black Lives Matter protests, intensifying political divisions, the climate crisis, and more, 2020 has been very challenging. These difficulties were exacerbated by the fact that we were all forced to stay home. Compound this with your kids forced to attend school online (now you’re a teacher too), the fear of you potentially losing your job or your business, and the risk of losing your wealth due to market instability, it is no wonder why we are all stressed out.

Despite all of this, the market has delivered an impressive return this year. In fact, we have reached new all-time highs. As I write this, the S&P 500 TR is up 14.35% YTD, far better than any of us would’ve predicted in March, the peak of the hysteria.

A lot of people are quick to compare the recent stock market performance to that of the economy — “It doesn’t make sense that the market is doing performing so well when half of the economy is shut down, and the people continue to lose their jobs.”

Yes, GDP levels have dropped significantly, and the unemployment rate spiked to record levels. However, the rebound thus far has been pretty impressive.

These rebounds show that the economy is continuing to recover. History will show that the 2020 recession is the deepest since the Great Depression, though one of the shortest on record, possibly the quickest ever. Because both the Unemployment rate and GDP are lagging indicators, they confirm what has already happened, not what is yet to occur.

The stock market, however, is neither a lagging nor a concurrent indicator. It is instead a forward-looking-indicator that is continuously attempting to price in probable future equity cash flows. The minute-by-minute, day-by-day moves in the stock market act as a price-discovery tool, digesting new information as it arrives.

THE MARKET REACTION TO COVID

When news of COVID-19 cases began to spread in February and March, the stock market reacted accordingly. The S&P 500 fell fast, the fastest in history. At the time, we did not know what COVID-19 was or how deadly it can be. Were we looking at something similar to the ebola epidemic that killed 11,000 people or the bubonic plague that wiped out over half of Europe’s population in the 14th century? (LiveScience) Are we talking tens-of-thousands or tens-of-millions of deaths in the US? The stock market began to price in a worst-case scenario. The downside risk of a significant pandemic has the potential to cause us to lose a large number of human lives and the possibility of a major reversal of human progress.

Once we began to understand this disease’s true nature, our worst-case fears started to dissipate, and the market reacted accordingly. Yes, COVID is extremely serious and deadly. Both of my grandparents are currently battling COVID, along with many other family members in my home state of Colorado. I am not downplaying this virus. However, it is not as severe as our fears indicated earlier this year.

Unprecedented action by the Federal Reserve and Congress has also had a significant role in the stock market reversal. The total SPX drawdown from its February 19th peak to its March 23rd valley was -34%. It could’ve been much worse if the Fed did not act swiftly and boldly.

The trillions of dollars in fiscal stimulus combined with the Fed’s actions acted as a catapult for the market. It only took five months before the S&P 500 broke above its all-time high.

STOCK LEADERS

While the major averages have rebounded impressively, this rally has been extremely uneven, with tech growth stocks leading the way. The top 5 YTD SPX performers are five stocks that nobody would’ve predicted earlier this year.

More importantly, though, this is the year of innovative stocks. COVID has accelerated technological growth and its subsequent adoption. Businesses that have been reluctant to embrace digital transformation or those that are unwilling to be flexible during these times now find themselves in severe financial trouble.

A post-COVID world will be one where society has embraced remote work, digital content consumption, platformification, and digital health solutions. Cathie Wood, the founder of Ark Funds, states it best – “As is typical during periods of turbulence and fear, consumers and businesses are willing to think differently and change their behavior. As both look for cheaper, more productive, or more creative ways to satisfy their needs, we believe that disruptive innovation will take root and gain significant market share.” This is why we see those companies that offer faster, cheaper, more cost-effective, and creative products to their customers are gaining significant share. They are the prime beneficiaries of this radical change we are living in today.

Instead of going to a physical retailer to buy goods, people purchased their items online. Instead of meeting up with family or friends for dinner and a drink, people would order takeout and eat and drink at home. Instead of going to a movie theater, people are streaming their content. People are still consuming goods and services; they are only consuming them differently in this environment.

LOOKING FORWARD TO 2021

We believe that 2021 has a fantastic set up as there are significant tailwinds for equities. Life will likely never return to how it was in 2019, but 2021 will undoubtedly be better than 2020. Here are our most significant equity tailwinds for 2021:

COVID vaccine

Not a surprise to anyone, the most critical catalyst for equity returns is the deployment of the COVID vaccine. As enough American’s receive a vaccine, and as we approach herd immunity, we will begin to open our economy once again fully. Restaurant owners, bar operators, tourism employees, and others can finally return to work.

However, I suspect that the economic reopening plan will be lumpy and chaotic. Many Americans will opt not to receive a vaccine, many employees will prefer to work from home, and many businesses will have already closed their doors for good. The COVID shutdowns have done irreversible damage to many individuals and business owners, and some of them will not come out of this whole. However, those that have survived this will likely be stronger and able to capture more market share. This, in its simplest definition, is capitalism — survival of the fittest.

Terminal velocity

The economy continues to recover from the March economic shutdowns, and I believe that we are at breakaway speed / terminal velocity. The latest economic shutdowns will likely impact our employment figures, but it will not be enough to derail the recovery. Consumer demand looks very strong. Inventory numbers indicate that companies are having a difficult time keeping up with consumer demand. Leading Indicators continue to show robust economic strength. All of this points to a continued strong recovery.

Split Congress

The Democrats have secured the House of Representatives with a 232-197 advantage. The Senate currently stands at 50 Republicans and 48 Democrats. We are still waiting on the Georgia Senate runoff election results on January 5th, 2021, for the two remaining seats. If Democrats win both runoffs, the party will control the chamber because Vice President-elect Kamala Harris would break any ties.

However, if Republicans win one of the two races, they will maintain control. I don’t know how it will turn out, though it seems likely that this will be the case. Still, we will know very soon. If the Republicans maintain control, then we have a split Congress. From a capital markets perspective, this bodes well for near-term equity returns. There will be no changes to the tax code, and President-elect Biden will find it difficult to undo a lot of the deregulation President Trump has enacted over the previous four years. Again, from a capital-market perspective, this is good. Capital markets perform best under these conditions.

IN THE END

At some point, we will have to pay for the fiscal deficit spending we’ve seen this year. The CBO currently projects a $3.3T deficit for FY2020. Are we only going to print more money to pay for this (this is inflationary and akin to MMT), or will we have to raise taxes at some point in the future? Who knows. We’ve been kicking this can down the road for decades, and I expect us to continue to do the same.

We also have to keep in mind that the markets and the economy are fluid and ever-changing. What we see now and what we expect to see in the future will change. Having an open mind and a willingness to change is the key to success. If 2020 has taught us anything, it is that life will place roadblocks in front of you. Be nimble and recognize that you can overcome them.

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