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WIA BELIEVES | 2021 Thesis - Recovery from Angst

WIA BELIEVES | 2021 Thesis - Recovery from Angst

| January 08, 2021

For me, as for many I would guess, turning the page on 2020 will be both welcome and with an excitement for what is next to come. The end of this COVID-clouded year closes the chapter on one filled with angst-filled challenges in nearly all aspects of our lives. What I like about the start of each new year is that it brings forth the opportunity to tackle new challenges, capitalize on fresh trends, and ultimately improve in meeting the needs of our clients. This week’s sad and eye-opening events at our nation’s capital have further reinforced the investment thesis I am suggesting to you here.

It’s been quite a while since we collectively have entered a new calendar year with so much pent-up optimism. Most economists and market prognosticators believe that 2020 was a dark valley from which we will emerge into the light through the first half of 2021. I understand why the outlook is so positive: Historic economic stimulus, momentum in vaccine distribution, clarity in government direction in Washington, historically low interest rates, and shockingly strong corporate earnings.  

But, while I share in this fundamentally based optimism for the markets in 2021, I have been in this business long enough to know that when the “pros” on the street seem to be in agreement on an outcome, it pays to consider the contrarian alternative also.  To further that point of exuberant optimism, at the retail investment level, the AAII Investor Sentiment survey hit a three-year peak of bullish enthusiasm right before the Thanksgiving holiday. The bearish and neutral sentiment of the first half of 2020 has now taken a backseat to an abundance of greed as markets have surged to new all-time highs.

As many of us know, those spikes in investor psychology often serve as counterintuitive turning points for markets on both the upside and the downside. That prompts us to consider a trend reversal, or at the very least, a sector rotation opportunity for clients to rebalance allocations. The way I see it, I too am optimistic and will be suggesting portfolios to address that dominantly positive investment landscape in 2021, however will diversify in ways that acknowledge potential risks.

Put differently, I believe we always must be prepared for two outcomes – the expected (continued equity strength through economic recovery), and the unexpected (volatility due to hiccups in the expected). 

The “Return to Normal” Opportunity. This is the economic reopening scenario that we have been tracking for several months now. A return to growth, prosperity, and tame inflation that meets with Goldilocks-style government stimulus. Continued low interest rates, a recommitment of corporations towards capital spending, and a Roaring Forties-like comeback of the consumer due to a receding global pandemic are the driving forces for this thesis. A calm geopolitical environment is another crucial piece of this puzzle as well.  Our focus in allocation here will be predicated on the following:

    1. Rotation into underappreciated “value” sectors, prime to benefit from economic expansion, like materials, industrials, energy and financials and away from, but not abandoning, over-extended large-cap growth sectors. In further refining this outlook, a shift towards small and mid-cap companies also makes sense at this stage in an economic recovery.  Similarly, a declining dollar and a relative undervaluation of foreign equities are reasons for a meaningful investment overseas in both developed and emerging markets.
    2. “Path to the Future” sector investing to take advantage of long-term societal and governmental shifts in how we work, how we live and how we communicate.  Portfolios will benefit from allocating to generational needs in healthcare and infrastructure spending, and to innovative changes including cybersecurity, payment systems, clean energy and the rapidly evolving tech areas of 5G, automation and cloud computing.  While some of these areas may currently fall in the aforementioned category of being potentially overvalued, they in my opinion merit being included as a significant part of client portfolios for years to come.  
    3. For those wanting to be more opportunistic short-term, investing in “Pandemic Recovery” sectors that should bounce back as vaccine distribution becomes more widespread – leisure, entertainment and travel, may prove to be good short-term catches.

The Contrarian Scenario. This would be considered more of an outlier event in the betting world. A scenario where things are unforeseen and just don’t work as planned. Perhaps there are problems with vaccine distribution or efficacy, or inflation exceeds all norms and Treasury yields shoot up unexpectedly, or geopolitical disruption intercedes, or the economic recovery just simply falls short of expectations. It would not be an outlandish result for a known or unforeseen factor to derail the lofty valuations of U.S. stocks. With cash levels low and investor confidence high, the outcome would be swift and merciless.

    1. Obvious but always worth a reminder – investment success for each investor is predicated on your personal risk/reward parameters and financial needs, and then making the investment commitment to an appropriate asset allocation strategy.  In other words, together we must get your interests right to have your allocation to equities, fixed-income and alternatives be comfortable to you and positioned to meet your expectations in both good and bad times.
    2. As a ballast to the potentially high-returning equity sectors discussed above, based upon your risk/reward profile, we must have an appropriate investment to the less volatile asset classes of fixed-income and alternatives.  With regard to that component, while The Fed remains committed to keeping rates low, we are suggesting a cautious posture in anticipation that in coming quarters the economy will improve, and that rates could rise along with inflation. In short, we believe the 40-year Bond Bull Market of declining interest rates is over, and therefore fixed-income holdings should now be kept in a short duration.  While out of favor over the past few years as rates have fallen and as growth stocks have soared, we believe the time is now right for diversifying “non-equity” allocations to investments in floating-rate income, real estate income, hard asset commodities and managed futures.

In summary, a new year brings about a perfect opportunity to step back and evaluate every position in client portfolios from a fresh perspective. For clients we will discuss further recommendations when in the next week or so we send your Q4 2020 Performance Reports.  For all clients and friends who have read this far, I hope you will find some value in our insights and suggestions and consider taking a close look through this lens at your own investments.

No one can predict exactly what will happen with any certainty. However, what we can do is responsibly prepare a roadmap for scenarios that will invite success no matter what the markets throw our way.

James and I want to wish you great health and wealth in the new year, and we thank you for taking an interest with us, in your future and ours.