With the first quarter of 2021 having come to an end, and now a year into the Covid Pandemic, I thought I would take this opportunity to take a brief "look back" and then provide a "glance forward" to investments in 2021 and beyond. Foremost though, while Covid has taken its toll on many parts of our lives, I hope that you and yours have come through this historic mess without impactful personal loss.
A Look Back
This time last year, the World Health Organization recently had declared that the spread of Covid-19 constituted a worldwide pandemic. Stringent measures in the U.S. were being taken to slow the spread of Covid and “flatten the curve.” The lockdowns and shelter-in-place orders dealt a body blow to U.S. economic activity. Investors, who attempt to price in economic activity over the next six to nine months, had no prior experience to handicap a shutdown and eventual reopening of the economy. It was if we were driving through a dark and foggy night with no headlights to guide our path.
Consequently, investor reaction was swift, and the first bear market since 2009 descended upon investors. Volatility was intense. In just one day, the Dow Jones Industrial Average lost nearly 3,000 points, or 12.9%. That day accounted for over 25% of the Dow’s nearly 11,000 point peak-to-trough loss. Six weeks from the mid-February top, the DJIA bottomed on March 23 at 18,591.23, having decline just over 37%. The bear market lasted barely over a month. It was a swift and deep decline, but it was the shortest bear market we’ve ever experienced.
The ensuing rally has been nearly unprecedented. Since bottoming, the DJIA advanced an astounding 77.4% through March 31, closing at 32,981.55.
For perspective, let’s back up and take a broader view. Since World War II, there have been six other bear-market selloffs of at least 30%. In each case, the market posted strong returns in the first year, with an average gain of 40.6%. Gains ran into year two, with an average increase of 16.9%; however, the average pullback during those six periods: 10.2%.
That shown, while we remain optimistic for the economic recovery, and remain committed to equities, let’s not discount the possibility of a bumpy ride this year.
A Glance Forward
Treasury bond yields have jumped as the government has embarked on an expensive $1.9 trillion stimulus package, and talk of new spending from Washington is gaining momentum. Further, bullish enthusiasm can sometimes spark unwanted speculation.
Might the economy overheat and spark an unwanted rise in inflation? Might rising bond yields temper investor sentiment? Up until now, investors have focused on the rollout of the vaccines, reopening of the economy and the benefits these are providing. Many expect a "Roaring 20's" redux, just a century later! In addition, we have received a number of accommodative statements from Fed Chairman Jerome Powell on the need for long-term supportive actions by the U.S. central bank. The consensus seems to be that zero-interest rate policy and other liquidity programs will be the norm for the next year at minimum.
The combination of these factors has continued to be supportive of the stock market in a broad sense and investors continue to project risk-on behavior during any minor dips. Today, momentum favors bullish investors, but valuations seem stretched, at least over the shorter term. When markets are surging, there is a temptation to load up on risk. Yet, we’d counsel against being too aggressive.
New Governance & Policy Shifts
Today I received a call from a client offering up a comment, “Now that the Democrats passed the stimulus, the policy outlook seems to be much more mixed with some potentially good ones, and some potentially bad ones, at least as it applies to the stock market.” His thoughts resonated with me so much that I thought it would be a fitting subject to touch upon in my commentary.
The outcome of the presidential and congressional elections brought with them much speculation about the fate of several key government policy initiatives. Big agenda items such as the COVID-19 vaccine rollout, economic stimulus package, tax law changes, and infrastructure spending were still very much in question at the beginning of the year. Many of those questions now have been answered in the form of a largely successful vaccine campaign that has the United States on course to secure widely available supply for all adults by May 1. Furthermore, the passage of the $1.9 trillion stimulus package includes significant allocations to put cash in the hands of individuals, businesses, and states that need it most.
The major 2021 narrative thus far has been the swirling undercurrent of momentum swinging from growth to value, but the big-picture trend has been relatively steady. The low-volatility backdrop of this uptrend shows continued confidence in the reopening scenario as the pandemic recedes and a more conventional social environment is expected to ensue. It’s almost assured that the largely Democratic-led Congress will now turn its attention towards other initiatives such as infrastructure spending, green energy adoption, and tax law changes to fund these projects.
Democrats made the campaign promise that corporate tax rates would be boosted from 21% to 28% in an effort to shift the balance of power from Wall Street to Main Street. Additionally, there is a growing groundswell of support to break up “Big Tech” and “Big Banks” as a method of substantially re-distributing power and wealth from a select group of public mega-companies. While societal benefits are in the eye of the beholder and not to be judged by me, these policies have historically been challenging to the status quo of escalating corporate profits, investor confidence, and economic expansion.
The bottom line is that U.S. government policy is going to play a significant role in the next several years of market activity and we need to be prepared to deal with the concomitant opportunities and risks. So, we want to arm you with the tools for identifying and deploying to areas of the market that should experience positive effects during this political environment. It’s also our objective to help shield portfolios from areas most likely to experience difficult circumstances if these tax laws and regulatory changes come to fruition.
Following is an outline of the Pros and Cons, consistent with our last blog about "Themes for 2021", that we are sharing with clients to chart a path through the choppy seas while this societal and governmental transition evolves. In summary, we remain bullish on equities and real assets, bearish on bonds and per below, feel specific allocations will add value in risk-management and future returns.
• Policy Beneficiary 1: Consumer Spending. The much anticipated post-vaccine flood of consumerism, travel and leisure will likely yield very strong earnings to these now scaled-back-overhead companies in these industries. Owning "recovery" sectors both at the consumer and industrial levels makes sense.
• Policy Beneficiary 2: State and Local Governments. The stimulus package includes hundreds of millions of dollars to support Covid-impacted budgets. This makes municipal bonds that much safer, and therefore more attractive, especially if higher personal income taxes come about.
• Policy Beneficiary 3: Infrastructure. At least part of the Build Back Better plan will pass and that will be a tailwind for infrastructure plays in not only roads and bridges, but clean energy and the power grid as well. We believe basic infrastructure and "future-tech" both have a place in portfolios.
• Potential Policy Damage 1: Higher Corporate Taxes. The corporate tax rate will increase (as may personal or cap gains rates), so decade-long depressed "value" stocks, as well as small-caps, may be finally ready to outperform over-priced "growth" stocks.
• Potential Policy Damage 2: Break Up Conglomerates. “Big Tech” and “Big Banks” are the target of regulation in Congress. Bigger may not be better.
• Potential Policy Damage 3: Inflation. Stimulus packages and increased government spending and borrowing will push inflation. Hard assets and short-duration fixed-income should be owned, while heavily-leveraged companies and long-term bonds should be avoided.
I hope you have found this Look Back and Glance Forward to have been of interest, and stand by to hear from you if you feel we might be of help in any way.