The Quarter in Review | 4Q 2020
The year 2020 proved to be one of the most tumultuous in modern history, marked by a number of developments that were historically unprecedented. But the year also demonstrated the resilience of people, institutions, and financial markets. For investors, the year was characterized by sharp swings for stocks. As the pandemic worsened in March, the S&P 500 Index declined almost 34 percent. This was followed by a substantial rally in April, and by August stocks had fully recovered from the March sell-off.
The 2020 economy and market also underscored the importance of staying broadly diversified across companies and industries. The downturn in stocks impacted some segments of the market more than others. For example, airline, hospitality, and retail industries tended to suffer disproportionately with people around the world staying at home, whereas companies in communications, online shopping, and technology emerged as relative winners during the crisis. However, predicting at the beginning of 2020 exactly how this might play out would have proved challenging.
FOURTH QUARTER RETURNS
U.S. stocks rallied hard, up 14.7 percent in the quarter. International Developed stocks performed even better, up 15.8 percent. After severely lagging for the better part of the year, during the fourth quarter Value stocks finally staged a strong comeback, outperforming Growth stocks for the first time in over five years. Small Cap and Emerging Market stocks led the rebound for all stock categories, sharply up 31 and 22 percent respectively just in the fourth quarter.
In the middle of March when panic and fear where running rampant and markets were down more than -30 percent, few could have imagined a balanced 50/50 stock-bond portfolio would return +9.21% for the full year.
ALTERNATIVE INVESTMENTS
With inflation concerns bubbling up due to massive government stimulus combined with strong demand from the expanding economic rebound, the Bloomberg Commodity Index jumped 10.19% in the quarter, still down over -3 percent for the year. Real Estate Investment Trusts (REITs) recovered some of their massive year to date declines, up +12.9 percent but still down -11.2 percent for the year.
LOOKING FORWARD
Moving into 2021, many questions remain about the pandemic, new vaccines, business activity, changes in how people work and socialize, and the direction of global markets. Yet 2020’s economic and market tumult demonstrated that markets continue to function and that people can adapt to difficult circumstances.
On the positive side, unemployment is back down to around 6 percent from its peak of over 15 percent. Also, we are on the cusp of seeing historic year-over-year improvements in GDP (Q2 2020 vs Q2 2021) not seen since the 1950s. The comparison is skewed as the comparable period in 2020 was the worst economic quarter during the entire crisis. Regardless, the improvement is real and is substantial.
In addition, the various rounds of economic stimulus (distributions) – extended unemployment insurance benefits (UI), one time stimulus checks, Payroll Protection Program (PPP) initiatives, along with other various support as outlined below, have created enormous savings. A few weeks ago, U.S. Banks reported that on an aggregated basis, retail checking and savings account balances were up over $1 Trillion since the pandemic began. All of these figures are BEFORE taking into consideration the $1.9 Trillion bill that is in front of congress for additional stimulus. This is a massive amount of cash available for consumers to spend that they did not have a year ago.
MARKET VALUATION
How “expensive or cheap” the market is can be noted by the Price Earnings or P/E Ratio. The higher the ratio, the more expensive the market is. Outlined below are valuations for the S&P 500 at four different key points in time. The four dates are the dot.com peak (3/24/2000), right before the last financial crisis (10/9/2007), last February before COVID hit (2/19/2020) and then at year end (12/31/2020).
As you can see, the market is currently the most expensive (22.3 x earnings) it has been since the peak of the dot.com bubble back in March 2000 (27.2 x earnings).
S&P 500 3/24/2000 10/9/2007 2/19/2020 12/31/2020
Index Level 1,527 1,565 3,386 3,756
P/E Ratio (fwd.) 27.2x 15.7x 19.0x 22.3x
Then there is the so called “Buffett Indicator.” It is simply the ratio of the country’s stock market capitalization relative to the overall GDP of the country. It is an extremely simple indicator not to be used over a day or month but has been fairly reliable in forecasting the market over a number of years.
Are these two market valuations telling us the market is about to crash? Not necessarily.
We don’t look exclusively at one specific economic or market indicator. So, what do we know? The economy is strengthening and consumers have record amounts of cash. We also know that on a historical and relative basis, the market is quite expensive right now. We cannot confidently say how long this will continue. As one of our favorite research groups like to say, and with which we agree, “market peaks and bottoms are processes, not points in time.”
FINAL THOUGHTS
2020’s outcomes remind us that a consistent investment approach is a reliable path regardless of the market events we encounter. While it is unlikely we’ll ever experience a year like 2020 again, many of the principles outlined below are timeless, and can serve as foundational reminders that are applicable every year.
INVESTMENT PLAN
An investment philosophy serves as a compass to guide you through turbulent times. When you have a compass, it doesn’t take drastic directional changes to find your way. Establishing and adhering to a well, thought-out investment plan, ideally agreed upon in advance of periods of volatility, you can remain confident and calm during periods of short-term uncertainty.
ALIGN PORTFOLIO RISK WITH GOALS
As investors, our risk appetite often changes based on the market environment we are in. In early March when we experienced the fastest bear market in history, some would have slept better at night knowing they had allocated more to bonds or cash. In April, when the market had its best monthly return since 1987, those same investors would have felt better knowing they were allocated more to stocks. Point being, you want to have a plan in place that gives you peace of mind regardless of the market conditions.
PATIENCE
The 2020 market downturn offers an example of how the cycle of fear and greed can drive an investor’s reactive decisions. Back in March, there was widespread agreement that COVID-19 would have a negative impact on the economy, but to what extent remained unclear. Who would have guessed we would've experienced the fastest bear market in history in which it took just 16 trading days for the S&P 500 to close down over 30% from a peak only to be followed by the best 50-day rally in history? I would be hard pressed to find someone who had that in their market timing forecast. The good news is – you don’t need to be able to time markets to have a positive investment experience.
UNDERSTAND YOUR PORTFOLIO
Investors want reliable portfolios with robust risk controls. Unfortunately, it often takes a market decline for many to take a closer look at what is actually in their portfolio. In times of market stress, investors rely on the fixed income portion of their allocation to serve as the ballast of their portfolio, helping to provide downside protection.
This is why, at Trinity, we categorize holdings into two broad categories – Risk Assets and Stable Assets. Risk Assets are mostly equities or stocks that have a high risk, high return character, holdings which over the long term will account for the majority of growth in your portfolio. Stable assets are just that, they do not go up or down to much degree but are steady, a ballast in your portfolio during volatile times.
Just because a portfolio has a lot of holdings, does not necessarily mean it is diversified. We have found that simplicity, low cost, and clearly understanding what is in a portfolio is most important.
STAY DISCIPLINED
Financial downturns are unpleasant for all market participants. While no one has a crystal ball, adopting a long-term perspective can help change how you view market volatility.
Read the news to be an informed citizen, not for advice on how to navigate the financial markets. Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future, while others tempt you to chase the latest investment fad. When headlines unsettle you, consider the source and maintain a long-term perspective – growing wealth has no shortcuts.
Everything starts with creating an investment plan based on market principles, tailored to your specific needs and goals. Understanding cash flows and investment risks while maintaining broad diversification can add real value to any plan.
Remember, we are here to help. This also is where the time invested upfront with each of you shows its value. By formulating a solid and adaptable financial plan together and discussing liquidity, cash flows, and reserves, provides the solid footing needed for times like these with many changing facets.
We greatly appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss.
We wish you, your families, your friends, and your colleagues all the best and a great start to the year.
Please follow this link to read the complete Quarterly Market Review | 4Q 2020.