Year-End Investment Outlook

January 11, 2021

2020 was a challenging, yet surprising, year for all.  At the start, the markets were reaching new highs as we contemplated when and how an historic economic cycle would end- surely not on exhaustion.  Who could have predicted that a global pandemic would not just ignite a recession, but literally stop the world?  As we isolated, bought masks, and spent more time with family, we also worked our way through a major service-sector shut-down, varying domestic social tensions, a record-setting vaccine development, and a contentious election.  We face the new year with renewed hope, but lingering questions.


The 2020 Recession:
Most recessions occur from excesses.  Historically, recessions were kindled by inventory excesses and more recently by asset/financial bubbles. These excesses would take time to build up and then would take even more time to stabilize and rebuild after their implosion.  This is not the case in 2020.  This year’s recession was ignited by a health crisis that caused an immediate and wide-spread collapse of activity. With no excesses to relieve, the effects of this recession may be more quickly reversed than we imagine.  As more and more people are successfully vaccinated around the world, activity and growth may rebound stronger and more quickly than even current forecasts predict. By mid 2021, we are likely to see strong growth comparisons and by 2022 we may see full activity regained. 


2021 Opportunities and Risks:
As with most recessions, full activity may not look the same as it did before the recession. Unemployment, for example, is recently stuck at just under 7% as middle market hospitality and service businesses continue to shutter on every Main St. in the U.S.  Those workers will again find employment, but it may take time and it may require new skills, leaving a persistent drag on the economy.

To aid our recovery out of this recession, interest rates are again sitting at 0% and our Federal Reserve has repeatedly committed to maintaining low rates and providing liquidity to support the economy.  This is benefitting the housing and construction sector where building permits were up over 6% this past month.  Rental rates are collapsing in large cities, but suburban demand has skyrocketed as our population redistributes across the country.  The diaspora will bring not only new construction, but further economic growth through new service demands and new business opportunities in smaller communities.

Finally, the cost of this recovery has been primarily borne by our federal government racking up unprecedented levels of debt, amidst current demands for even more fiscal support.  Be prepared for renewed debates around fiscal responsibility and potential spending cuts even as the economy needs continued support.  Academics are increasingly debating the significance of government debt levels when leaders control the ability to print currency, manage liquidity, set interest rates and then determine spending.   Expect to start hearing more about Modern Monetary Theory (MMT)- a macroeconomic theory that, in part, suggests government debt levels may not matter when countries can always print more money, unlike a business or person. MMT advocates are starting to get more attention as their concepts may be critical to sovereign financial management going forward.

For the markets, financial liquidity and low interest rates support high stock valuations, while the pace of the economic recovery will determine future earnings growth for stocks. Will easy earnings comparisons in 2021 be enough for stocks to maintain their current valuations?  Will earnings gains surprise, so that stocks “grow” into current valuations? It is not unusual for valuations to appear very high at the bottom of a recession when earnings are depressed, even as the market may have plenty of upside opportunity going forward. “Valuation” and “growth” will likely be the key metrics to watch next year, and we will not be surprised if either of these sparks bouts of volatility for specific stocks or the market as a whole.

 


Your Portfolio:

When the market collapsed in response to the emergence of the COVD virus, we responded as we did in 2008- we reviewed the risk/reward of all positions in the portfolio, retaining only those in which we had the highest confidence.  These are the positions we added to.  When the market stabilized a bit, we went to our watchlist and added positions to portfolios that we believed offered attractive returns from the market’s depressed levels.  From those lows of late March and early April, technology investments led the market rebound straight through the summer.  We participated in the rally and took profits where we thought positions had gotten ahead of themselves.  We also continued to invest in areas of the market that were not participating in the strength, and we felt were undervalued.  The tech rally trailed off this past fall and our contrarian investments benefitted.  We are proud of your portfolio results this year and are now focused on positioning your portfolio for those areas that can benefit from improving trends in 2021 and 2022.

 

We look forward to the New Year and wish you a Happy, Healthy and Prosperous 2021!