2020 Financial Market Re-Cap
Who wants to repeat 2020? COVID-19, the accompanying economic fallout and civil unrest were the major issues of a year that many of us hope to never see again.
Despite all of that, the U.S. stock and bond market for the most part finished the year positive. Considering the plunge in prices in February and March, that is astonishing. We credit a strong pre-COVID economy, operation Warp Speed, and substantial Federal Reserve action for the recovery.
In a year filled with uncertainty and anxiety, we are again reminded that it is often a mistake to make investment decisions based on fear and emotions.
2021 Q1 Outlook & Beyond
Georgia Senate Race Impact
As markets have a tendency to react in a variety of ways, we waited to write the newsletter until the outcome of the Georgia Senate Runoff Election was known. Markets historically tend to favor split control of government. Assuming party-line voting occurs in Congress, then the Democrats will have complete control of Washington, DC for the first time since 2009-2011. The important question for us to ask is, how will this affect the economy and financial markets?
First, it is important to remember that the day-to-day functionality of the U.S. economy does not lie in the hands of the President or Congress. The Federal Reserve is more responsible for the day-to-day operation of the economy. The Fed has very clearly said that they do not intend to change from the current policies for at least 2-3 years.
Second, we frequently remind our clients that we believe our founding fathers were divinely inspired geniuses. The writers of the U.S. Constitution designed our government in such a way that it is hard to make major changes to our laws. For evidence, recall that during President Obama’s and President Trump’s first two years in office the Democrats and Republicans had complete control, respectively. During each of those first two years, only one major legislative bill was passed—the Affordable Care Act for Obama and tax reform for Trump.
Third, Democrats do have both chambers of Congress, but their margin of control is razor thin. It is our view that financial markets and the economy generally like to maintain the known “rules of the game.” It seems likely to us that while there was a lot of campaign discussion on tax increases and mega-infrastructure deals, those types of policies have a lower likelihood of being passed coming out of a recession and with a razor thin majority. Thus, we would not expect major “game changing” rules to be passed in the short-term.
Finally, we would anticipate that in the short-term it is likely that Biden and Congress will try to provide a third round of economic stimulus. In the short-term, it seems reasonable that financial markets will like this idea. In essence, markets will probably see the Georgia outcome as getting more “free” money and no immediate tax increases. Obviously, the problem is that nothing is “free” and eventually our significant budget problems will have to be addressed or major economic upheaval will occur.
As we have said before, the U.S. economy went into the COVID induced shutdowns in extremely solid shape. Yes, the 2nd Quarter was the largest economic collapse since the Great Depression, but the 3rd Quarter rebound was also the largest on record.i
The economic rebound appears to have continued during the 4th Quarter. The Atlanta Federal Reserve’s GDPNow indicator is projecting 4th Quarter 2020 GDP growth of almost 9% annualized.ii With GDP as a measure, the wheels of recovery are clearly turning.
Unemployment has dropped dramatically from the April 2020 high of 14.7%.
iii Currently, U.S. unemployment is 6.7%iv—still significantly higher than the pre-COVID level of 3.5%, but manageable. We would also point out that South Carolina currently has one of the lowest unemployment rates in the U.S. at 4.4%.v
Finally, employee wage growth is mostly in line with the pre-COVID rate of 3.7%.vi
Taking wage growth with improving unemployment numbers suggests that consumer spending is likely to be strong. As we have constantly stated over time, consumer spending accounts for over 65% of the U.S. economy. When consumers spend, the economy grows.
Federal Reserve Action
The Federal Reserve has consistently stated that their intent is to keep short-term interest rates low for the foreseeable future. This is evident in their “Dot Plot” as it appears that they plan to keep short-term interest rates low until at least 2023.vii Money is cheap and will remain so, fueling the economy with historically low borrowing costs.
An issue on our radar is inflation. When both the Federal government and the Federal Reserve provides stimulus as they have, it can result in inflation. If you are of the age that you remember the inflation produced in the Jimmy Carter economy, you know how bad high inflation can be. Our view is this needs to be watched closely, but there is nothing to act on as far as changes in investment policy now.
Stock Market Update
As we stated earlier, the stock market was an absolute rollercoaster in 2020, but finished mostly positive.
Independent of which analytical measure we use, we would suggest that the U.S. stock market is overvalued. To be clear, this does not mean that we are due for a major crash or that U.S. stocks cannot go higher, but valuation does matter. We think we will see a change in how aspects of the stock market perform in 2021. We tend to favor small cap and value in U.S. stocks and emerging market stocks. These sectors of the stock market have been “unloved” over the last three years—we think that may change.
We would generally caution investors against making radical strategy changes based on fear and anxiety on the one end and exuberance on the other end. We think it is smart to keep your long-term financial goals in focus. For deploying new cash to the stock market, we think it is wise to use a dollar cost averaging strategy. Finally, we believe in ‘buying low” and using periods of weakness to buy into the stock market. However, this does require patience. Should an opportunity present itself, we will act accordingly.
It is our hope that you sense a bit of optimism in our newsletter as there are many positives to consider. Multiple COVID vaccines appear to be successful and are hopefully going to be available to the vast majority of people within the first half of 2021. We see continued evidence of an economic recovery. We see interest rates remaining low serving as a tailwind for consumers.
We are similar to most of our clients in that we have strong personal feelings about the politics. We, like our clients, love and revere this country and the freedom and opportunity that we enjoy. We believe, however, that our job is to provide the best advice we can to clients in their financial, retirement, and estate planning goals. Additionally, it is our job to provide investment management in accordance with your goals and objectives. That demands that we take an extremely objective view of the situation that is free of our own personal political views. We constantly strive to do exactly that.
We will continue to monitor the economy and financial markets and we will continue to communicate what we think. It is boring and we say it often. Focus on your own situation. Do not make decisions in haste. Put a significantly greater emphasis on long-term goals and objectives than short-term news cycles. Do not try to jump from one investment strategy to another in an attempt to chase returns. Focus on where the ball is going, not where the ball has been.
Should anything change in our thinking, we will advise accordingly.
God bless you and your family for a terrific 2021!
We look forward to talking with you soon!
Securities offered through First Heartland Capital ®, Inc., member FINRA/SIPC. Advisory Services offered through First Heartland ® Consultants, Inc. Walker, Higgins & Associates, LLC and Walker, Higgins & Associates Wealth Management, LLC are independent of First Heartland Capital ®, Inc. and First Heartland ® Consultants, Inc.