Market Update - November 2020
Evidently, every year brings surprises that are, by definition, impossible to predict. In 2020, it turns out that was a global pandemic (let's hope 2021 will have more mercy!). Our objective is not to predict the future, but rather to help you better understand what is happening in the world economy from a stock market perspective. In doing so, we hope to provide insight into how the news effects our portfolio management decisions.
This months email will both reflect on the incredible past month we have had, as well as provide thoughts on what we predict for 2021.
For those of you that we don’t get a chance to speak with – From all of us here at Creed Capital, we want to wish you and your family a very happy holidays!
With only four weeks left before officially closing the books on an eventful 2020, U.S. equity markets in November posted their best monthly performance since April (Chart below) to finish the period near an all-time high.
Two major sources of uncertainty eased in November.
1. The U.S. election outcome. With President-elect Biden and a renewed Republican majority in the Senate, the stock market can carry on its march knowing that U.S. foreign policy (and virtually everything that goes through the White House) will soon be much more predictable than under the current administration. In addition, without Senate control, Democrats are unlikely to succeed in raising corporate taxes as they had envisioned, another positive from a stock market point of view.
2. The second source of uncertainty that dissipated in November is by far the most important one: how effective and when would COVID-19 vaccines be ready for distribution? The logistics are still being worked out, but there is now little doubt that a significant percentage of the population will be vaccinated by the end of the first quarter of 2021, a scenario that was hardly conceivable just a few months ago (Chart below).
Clearly, the risk of a temporary market pullback still exists, as bullishness is nearing extreme levels. However, not only is the timing of this potential retreat impossible to predict, but its downside risk remains limited by two important cornerstones of the current bull market: ultra-accommodative monetary conditions and a sustained recovery in economic growth. As we have been saying since summer, this is indeed what has happened in the last few months, and it is even more true now that several highly effective vaccines are on the cusp of being distributed to millions.
…Bring on the New Year!
The latest set of economic data is unequivocal. We are at the beginning of a new business cycle that started last May and is, therefore, only 7 months old. The average lifespan of an economic cycle since 1960 has been 7 years, the last one having lasted 11 years (Charts below).
This does not mean that the economic (and, therefore, stock market) recovery is immune to any potential setbacks. A first key risk for 2021 concerns the speed at which the inoculation of a large part of the world's population can take place without further waves of contagion forcing governments to maintain or increase containment measures. It should be noted, however, that the global economy is already demonstrating considerable resilience despite the persistence of COVID in recent months.
One reason behind this impressive resilience is presumably the unsuspected impact of fiscal stimulus that was implemented early in the crisis. It significantly strengthened disposable income and savings (Chart below), an unprecedented situation in times of recession.
All evidence suggests these excess savings are likely to help feed further economic growth in 2021, insofar as better control of COVID-19 will ultimately allow for a permanent economic reopening and an increase in consumer confidence.
With regards to central banks, intentions are clear: maintain accommodative monetary conditions for as long as it takes to ensure a full economic recovery. In concrete terms, this means we should not expect to see any rate hikes on either side of the border for (at least) the next two years.
Simply put, the bar for future rate hikes is higher now than at any time in the past 40 years. But, with the substantial government indebtedness incurred in fighting the war against COVID-19, there is little doubt that real rates will remain negative for several years, helping to deflate the debt burden. This is a playbook similar to the one observed following the First and Second World Wars.
All of this means that the path of inflation (and inflation expectations) a second key risk for 2021 will have to be monitored closely. Too little inflation would mean failure of current monetary policies. Conversely, too much inflation would likely compel central banks to raise rates at the risk of undermining the economy. For now, the most likely scenario is gradual recovery of inflation expectations at slightly above 2%.
The flood of good news in recent weeks has, unsurprisingly, resulted in a sharp increase in investor optimism. This is reflected in our market sentiment indicator (Chart below).
In our view, this undoubtedly leaves the market exposed to a modest pullback in the short term (as it usually does when optimism gets extreme). Taken in context though: we recently learned that the exceptional research efforts of the global medical community have led to the discovery of not just one, but 3 separate vaccines for the world’s worst pandemic in 100 years - and this, at a much faster pace than originally anticipated. Moreover, the steady drum of political theatre and policy volatility of the last 4 years is set to dial down under President Biden, accompanied by Janet Yellen as Treasury Secretary, a highly respected figure who will cooperate well with the Federal Reserve. If sentiment was not signaling some form of optimism given these circumstances, then the indicator would surely be broken!
The pandemic backdrop gave rise to a total domination of defensive, large-cap, high-growth stocks in 2020. For instance, the 5 tech giants (Facebook, Apple, Amazon, Microsoft and Google) are responsible for more than half of the S&P 500's annual performance (Chart below). We don’t expect tech stocks to do poorly in 2021, but they should nonetheless yield their place at the top of the podium to others.
A strategy we favour for 2021 is the "Dividend Aristocrats," i.e. quality companies that have paid and grown their dividends for a minimum of 25 consecutive years. Historically, dividend aristocrats have tended to outperform when interest rates are low. This is logical, since the lower the yields that bonds offer, the higher the attractiveness is of companies that can ensure strong dividend yields. However, in 2020, investors' only concern was seemingly to find pandemic-immune companies, so this relationship completely broke down. We believe this rupture to only be temporary. The chronic lack of assets generating reasonable levels of income is an issue that the monetary response to the pandemic has aggravated and it is here to stay. Consequently, these companies should gain popularity and not necessarily only among equity investors.
We’ll leave it there for this month – please email me if you have any specific market questions. And as always, please feel free to contact any of us to discuss your individual portfolio.
We look forward to another great year working with you in 2021!