| 2021 Outlook|
With the U.S. election behind us, a new stimulus package, and three vaccines racing to the public, we can paint a fundamentally better picture for the economies of the world in 2021. We see re-openings, strong public policy support, and pent-up demand as three factors that will drive GDP higher, shut the door on the pandemic-induced recession, and usher in a new business cycle. As companies benefit from improved demand conditions during 2021, earnings and cash flow growth should follow which should move stock prices higher. Thus, we are cautiously optimistic that the economy will return to a good footing and the stock market will rise.
However, we believe that much of 2020’s strong gains already incorporate these 2021 expectations outlined above, and therefore the market’s return in 2021 may not be as robust as this year’s economic return. Additionally, we suspect that the path to recovery will start off with a whimper in the first quarter as we face the worst of the pandemic and its effects on the economy and employment. We believe corporate earnings and the economy will pick up steam in April-May, and gain momentum for the remainder of the year. We need to get through a few difficult months first. The economic challengers early on may bring about market uncertainty and volatility. We therefore do not believe the ultimate gains in the market will be a straight path upwards.
Let’s see what the year may offer by examining four key areas we think the market will take direction from in 2021: COVID-19, the economy, government policy, and corporate earnings growth.
Clearly, a large factor in this year’s economic growth is simply, “when can it fully reopen?” The answer is intricately tied to the path of the virus and the path of vaccination. While 40 million doses were produced and delivered in December to inoculate 20 million people, according to the government, the actual vaccinations in arms were much lower (around 8.3 million people as of 12/31/2020). We need to do a better job of getting the vaccine into our population faster, as we race against a virus that is peaking in its contagion and creating hospital capacity issues.
The holidays in November and December caused an uptick in cases as seen in our state of Massachusetts and the overall U.S. (see graphs below). Thus, we are starting the year from a tough vantage point and presume things will likely get worse from and economic and employment view in the coming months. The faster we can vaccinate, the faster we can restart the economic engine.
Daily Confirmed Cases of COVID-19 in U.S. (through Jan 3, 2021)
Source: Johns Hopkins University & Medicine, Coronavirus Resource Center
Ultimately, vaccines should allow the world’s economies to reopen and get back to work. We have already begun to heal and shown improvement on a number of economic fronts since the great shutdown in early 2020:
- Existing home sales hit 15-year high in 2020
- Mortgage rates fell to an all-time low of 2.9%
- Pandemic fueled moves to suburbs and homes were up-sized with rooms for office/gym/study
- Housing had a multiplier effect – new paint, furnishings, upgrades
- Both manufacturing and service indexes were recovering to pre-pandemic levels
- Labor market continued to heal with unemployment rate at 7.9%, well off peak of 14.7% in April.
- Jobless claims continued to fall in 2020 (see chart below).
The International Monetary Fund (IMF) forecasts global growth of 5.2% in 2021, with growth outside the U.S. faster than their expected U.S. GDP growth of 3.1% (see chart below).
Vanguard’s team of economists and strategist are more optimist than the IMF and see growth of 5% in the US, 5% for aggregate international countries, 9% in China, and 6% in other emerging market countries. JP Morgan sees the opportunity for global growth at 5.7% in 2021 (the U.S. at 5.0% and back-end loaded). Most strategists are more optimistic than the IMF and put growth in the 5.0% range for global economies. The one outlier we found early on in the year was Goldman Sachs, which published a 6.4% global growth forecast for 2021 with U.S. growth at 5.6%.
Since the majority of American’s won’t get vaccinated until at least mid-2021, the last stimulus bill in December was needed, in our opinion, and may not be the last. The Georgia run-off looks like it will swing two Republican held seats in the Senate to the Democrats which could make further stimulus in early/mid 2021 a reality.
We expect the changing of the guard from Fed Chairman Jay Powell to incoming Janet Yellen will not result in any major policy shifts of the Federal Reserve. Short term rates will be kept low until inflation goals (2.0%+) are met and full employment is achieved. The latter goal is likely harder to attain and will take years as many able workers that removed themselves from the system will once again be counted in the base as the economy mends.
Corporate Earnings Growth
We come to our last key driver to market direction in 2021: corporate earnings. A strong rebound in earnings growth will help rationalize the high valuations on earnings and cash flow (referred to as price/earnings and cash flow multiples). We think that a rebound is likely to occur in 2020. Strategists forecast the S&P 500 earning about $170 per share, a sharp rebound from the pandemic levels of 2020 which were estimated at $138 per share. This 20%+ growth is from depressed levels and is fueled mostly from revenue growth and profit expansion (due to volume through put) and to a lesser extent from financial engineering (share repurchase). The graph below shows a 31 year history of S&P 500 per share earnings and consensus forecasts for 2020, 2021, and 2020 in blue).
Corporations took advantage of extremely low interest rates and sold debt to the public in 2020, creating excess cash on the balance sheets of many non-financial businesses. What companies will do with the cash and how it will impact earnings growth is the big question. If they choose to invest in technology, infrastructure, and/or human capital to propel growth, we could see upside to earnings growth and GDP projections for 2021.
Around the rest of the world, earnings growth is expected to be a healthy as well (see chart below).
Despite higher expectations of EPS growth outside the U.S., these countries’ market valuations and cash flows are much cheaper than the U.S. Forward price-to-earnings ratios (P/E) in non-U.S. countries as measured by the MSCI ACWI ex. U.S. index are forecasted at 16.7x P/E, 25% lower than the U.S. P/E of 22.3x . Dividend ratios around the globe are 70% higher than in the U.S. at 2.7% versus the S&P 500 dividend yield currently at 1.6%.
We continue to see good opportunities in the international markets. The backdrop of a weaker dollar, stronger GDP and earnings growth than the U.S., and cheaper valuations than the U.S. make the international asset class an attractive investment, in our opinion. Additionally, we believe we have a strong line-up of active fund managers in this asset class that can take advantage of over weighing strong trends, themes, and stocks. Our actively managed funds outperformed their benchmark handily in 2020, with an average return of over 37% versus the benchmark return of just 8%. We understand that past performance is not indicative of future results, but we believe a combination of strong manager selection and a solid weighting to the international space should bode well for our clients in 2021 and beyond.
The macro environment is supportive of equity markets. Fundamentals should improve and Federal Research and government should continue to be supportive, putting a safety net under the market. With rates so low, money will always look for the best return opportunity, and that continues to be equities.
With so much money moving into equities, valuations have moved higher. Indeed, we would characterize values as stretched with the S&P 500 trading at 22.3x earnings. We think the markets will be up, but not as much as 2020, as corporate earnings “grow into their high multiples.” We think today’s prices partially reflect the good news of tomorrow. The path to recovery is likely to be uneven and combined with heightened valuations, we see a high probability for temporary market pull-backs. We think 2021 is another year of market volatility. However, we do see the market ultimately ending the year higher and eyeing 5-8% total return (market appreciation plus dividends).
In summary, equity markets have historically always done well over a long period of time. The longer the assets are held, the more growth you’re likely to see. The path of least resistance is a higher market.
Putting things in perspective, the S&P 500 has returned 11% per year since 1932.
Source: JP Morgan, Guide to the Markets (data as of 12/31/2020)
We expect 2021 to be a boring year for bonds after what we witnessed in 2020. We think we are on target for very modest fixed income returns in 2021. With bond income producing all the return, as we suspect rates may rise a bit (and thus prices decline). It’s hard to see a material upside in fixed income returns in the near future with low economic growth rates, low inflation, and an accommodating Fed policy of low rates. Rates cannot move much lower putting a lid on price appreciation (bond prices move inversely with yields). And with low yields, you get low bond income. Thus, the combined return for bonds (price appreciation plus bond yield income) should be muted.
Municipals bonds are still attractive versus corporate bonds or Treasuries for those tax brackets of 32% and higher because the after-tax yields are higher as seen by the chart below.
Source: Bloomberg Barclays Municipal Bond, Corporate Bond, and Treasury Bond Indices, as of 11/24/2020
We have always viewed fixed income as the ballast in a portfolio. It should serve to keep the ship steady during turbulent times. It is a storer of value, not a growth asset. Bonds are a strong diversifier and compliment to the equity side of a balanced portfolio and should continue to perform that way in the future.
What could prove our forecasts wrong? There are certainly factors that could affect and/or change our market assumptions for 2021 and, given the year we’ve just had, theses caveats are worth noting. The following are a few potential obstacles to our market assumptions and potential catalysts that would prove our assumptions too conservative:
We are delighted to have closed the last chapter on 2020 and look to a brighter 2021 on the horizon. The vaccine rollout will likely be the most important macro event of the year. We will watch intently, hopeful that policy changes and shifts in the vaccine roll-out allow as many arms jabbed as possible as soon as possible!
As always, your Sandy Cove team is available to answer any questions about the markets or your portfolio. We wish you all a Happy New Year and a healthy and vaccinated 2021. If you were wondering how we fared in 2020, please read our blog 2020 Market in Review: Year of the Pandemic