Still trying to make sense of 2020? Here’s a quick wrap-up of what happened in the investment markets.
A year ago, no one could have foreseen the global pandemic poised to plunge the world into the worst crisis in decades, sickening millions, crushing entire industries, and panicking financial markets. To date, almost two million have died worldwide from the virus. Over twenty million Americans lost their jobs, pushing unemployment to levels not seen since the Great Depression. After reaching all-time highs in February, U.S. stock markets plummeted 35%, falling into the fastest bear market in history.
So how on Earth to explain that by December 31, when markets closed for the year, the S&P 500 stock index had rebounded to finish up over 18% for the year?¹ The Dow Jones Industrial Average (DJIA) closed the year up 9.7%, having crossed the symbolic 30,000 level in late November. The tech-dominated Nasdaq rocketed to new highs as well, and even the staid bond aggregate index closed the year up over 7%.
“If 2020 was the year of the pandemic, 2021 is likely to be the year of the vaccines, allowing the economy and society to return to normal,” write market strategists at JP Morgan.² But while we celebrate 2020’s market rebound, it’s important to remember that COVID is not yet conquered. There are factors that could delay the ultimate recovery, and the battle has inflicted lasting scars on our country.
This is why we diversify. As stock prices plunged last March, you may have noticed that other investments in your portfolio held their ground. Some – like high-quality government bonds – may have even gained in price, demonstrating the power of diversification, which simply means that different types of investments respond differently to external events. The real story of 2020 is that diversification paid off when it was needed most, and especially during March’s meltdown. Bond rates were pathetically low coming into the year and many investors did not understand why they should even consider owning bonds. Yet all investors wished they had held more bonds by late March. Lesson learned.
An unprecedented performance gap separated 2020’s winners and losers. The COVID economy created a new breed of company superstar – nimble, disruptive, and able to pivot quickly to fill the needs of the new locked-down, socially-distanced, and #WorkFromHome population. The biggest beneficiaries? Giant tech stocks – like Apple, Microsoft, Amazon, Alphabet and Facebook – which now make up one-quarter of the overall S&P 500 market capitalization. Growth stocks across the board crushed it, up almost 39% for the year,³ while value companies barely broke even. While Apple gained 81% for the year, investment legend Warren Buffett’s Berkshire Hathaway scratched out only a slim 2.4% return.
But that tide may be turning. As COVID recedes in 2021, we expect the dominance of momentum-driven, mega-cap growth stocks to wane, and longtime laggards like value, small cap and international to play catch-up. This was already apparent in Q4, when despite a venomous election, a staggering increase in COVID infections, and renewed economic shutdowns, nearly every major investment asset class rallied to outperform the S&P 500 Index. Diversification not only worked, it knocked the cover off the ball. Value beat Growth; Small beat Large; Non-U.S. stocks (and bonds) beat U.S.; and Emerging markets beat Developed. Given the state of the world, our best advice was—and continues to be—to diversify broadly, keep fees and turnover low, and rebalance systematically.
Lower for longer thwarts conservative investors, as the hunt for yield continues. The massive government response to stabilize markets and inject liquidity after COVID will create record national debt and leave interest rates “lower for longer,” driving cash and bond yields toward zero. A whopping 75% of all developed market government debt has negative real yields, meaning investors can’t make enough to keep up with inflation. Most investors still need bonds in their portfolio to reduce risk and produce stable income, but adequate exposure to long-term growth investments like stocks is essential to making your money last. An estimated $5 trillion of cash is still sitting on the sidelines. We know that today’s low rates pose unique challenges for investors, so talk to your advisor about developing a thoughtful long-term plan to capture the returns you need, while respecting your risk tolerance.
Some of the best opportunities in 2021 may be overseas. Foreign companies continue to trade at lower valuations and with higher dividend yields than their U.S. counterparts, making shares attractive to U.S. investors. And most importantly, compelling demographics and a growing consumer class mean big opportunities for leading global brands targeting emerging markets. Finally, downward pressure on the U.S. dollar—due to ongoing monetary stimulus and growing U.S. government debt—should help boost non-U.S. stock returns.
Do stocks still have room to grow? A return to normal would boost out-of-favor sectors like financials, energy, leisure, hospitality, and real estate. That doesn’t mean all those disruptive online technology companies we used to zoom, stream, and connect during COVID are all washed up. But they might just look a little less special when things return to normal. Stocks remain comparatively attractive given today’s lower interest rate environment, and quality dividend-paying stocks will continue to appeal to income investors disappointed with meager bond yields.
We learned markets and the underlying economy don’t always move in sync. Many observers were perplexed in 2020 over the apparent disconnect between the financial markets, hitting new highs, and the real economy, which was ravaged by lockdowns and layoffs. Even experienced investors admit being tempted to “sit it out” until the economy improved. But trying to time the market based on short-term headlines would be a mistake. Financial markets are always forward-looking. Markets hit new highs in December 2020 because they foresee better earnings ahead in 2021 as more people are vaccinated and daily life returns to normal.
Successful investors stuck with their plan in 2020. March’s precipitous stock plunge may have unnerved even experienced investors, but they know that pullbacks are often intense but brief. In fact, stocks rebounded from their March lows and raced to hit new highs in a record-breaking 126 trading days. That may not always be the case, but if investors learned anything in 2020, it is to get their investment strategy right in the first place, and then stick with the plan even in the face of scary but temporary setbacks. Trying to time the market in the heat of the moment can do irreparable harm to your long-term plans. Those who exited the broad market in March missed out on the amazing 60%+ rebound that followed.
A promising outlook but with continued uncertainty. We may see the light at the end of the COVID tunnel, but there are still challenges ahead. This year, we’ve experienced first-hand what it takes to successfully navigate even the most unexpected and treacherous market conditions. Start by focusing on what you can control with the solid foundation of a comprehensive financial roadmap. Add to that a diversified all-weather portfolio tailored to your unique situation and goals. Adapt as needed to meet changing conditions with the support and expert guidance of your advisor. Our mission is to help make our clients’ lives better, each and every day. We look forward to meeting the challenges of 2021 with you, and wish you a happy, healthy and prosperous New Year.