2020: A Historical Year to Forget
Fourth Quarter in Summary
The end of 2020 was a welcomed relief for many, marking the finish of an eventful year. A divisive presidential election eventually yielded a winner, but did not seem to have a healing effect as we saw with the January 6th capitol riots. Highly effective COVID-19 vaccines also began rolling out to frontline workers and at-risk individuals, but at a disappointing pace. With so much to spook investors in 2020, the major stock and bond markets performed surprisingly well for the year. U.S. markets led the way with 20.79%, followed by international stocks at 10.81%, and bonds returned an impressive 7.51%.
|Index||Asset Class||2020 Return|
|Dow Jones Total Market||U.S. Stocks||20.79%|
|MSCI ACWI ex U.S.||International Stocks||10.81%|
|BBgBarc US Agg Bond||Bonds||7.51%|
This left many investors scratching their heads as to how this could happen in such a year. While it’s impossible to know the exact reasons people kept buying into stocks during a time of uncertainty, the valuation numbers show us they’re willing to pay more for them on a price to earnings multiple. In February 2020, before the pandemic officially started, the S&P 500’s forward price/earnings ratio was 19.0x. By the end of 2020, that ratio jumped to 22.3x. In comparison, it was 27.2x at the height of the dotcom bubble two decades ago. This means that investors are pricing in a huge economic recovery after the pandemic ends. If corporate earnings don’t deliver on that lofty expectation in 2021, we could see a
major downturn in stock prices.
Stimulus & Long-term Inflation
During 2020, central banks throughout the world injected almost $8 trillion into the financial system. This was an unprecedented amount for an unprecedented global pandemic. And with President Biden in the Oval Office, congress will be working on another multi trillion dollar stimulus bill in 2021. Although the media focuses on fiscal stimulus, like direct payments to individuals, much larger sums of money are being added in the form of quantitative easing. Quantitative easing (QE) is a monetary policy where central banks purchase investment assets in order to inject money into the economy.
When people say the government is printing money and that will lead to inflation, they’re more likely referring to QE, not the literal printing of currency by the U.S. Mint. The money from QE is released to banks, who in turn loan money to businesses and individuals. One of the Fed’s mandates is to see inflation at a healthy 2%, but the consumer price index only grew at 1.4% in 2020, most likely from a lower demand of services and goods. Longer term, the Federal Reserve has to keep their eyes on inflation as the economy recovers. They only have two main tools at their disposal when it comes
time to slow the economy down: raising interest rates and selling back those financial assets (also known as tapering).
With a new president and Democrat controlled Congress, investors are now looking for strong leadership to get out of this pandemic and economic crisis. Two approved COVID-19 vaccines are currently being administered with potentially more could be approved. The two major challenges will be production and delivery of these doses. While some countries like Australia have been able to control the spread of COVID-19, the U.S. still has a lot of progress to make. Fiscal stimulus can only go so far to support individuals and businesses that are most affected by shutdowns and restrictions.
As mentioned earlier, U.S. stocks appear to be expensive, especially growth stocks and technology stocks. It will take substantial earnings growth to meet such high expectations. But with fixed income yields so low, it’s difficult for investors to trade their stocks for bonds. We may see a rotation from growth to value stocks, which tend to trade at a lower price/earnings ratio and often times pay dividends.
Wei Trieu, CFP®