While it was anything but a smooth ride for investors, 2020 turned out to be a very good year for the financial markets. The beginning of the year saw historic volatility as the coronavirus hit pandemic proportions and governments shut down their economies. The S&P 500 experienced three of its largest daily losses in history during the month of March, while also recording two of its best daily gains in history (source: S&P Dow Jones Indices). Many bonds also plunged during the month. The placid trading days of 2017 are now a distant memory.
Conversely, the last three quarters of the year were spectacular for stocks. By the end of 2020 the primary global stock indexes had more than recouped their losses incurred earlier in the year. Emerging markets in particular finished the year strong and have continued to rally sharply thus far in 2021. In 2020, the S&P 500 index of large domestic stocks was up 18.4%, the MSCI EAFE index of established foreign economy stocks was up 7.8%, and the MSCI Emerging Markets stock index was up 18.3%. Bonds also had a very good year, with the Bloomberg Barclays U.S. Intermediate Government/Credit Index finishing up 6.4%.
It is fair to wonder why stocks have rallied so well, especially considering our country is hitting new records in the number of daily deaths attributable to Covid-19 and government shutdowns are resuming in many parts of the world. The financial markets do tend to be forward looking, and much of the rally has been attributed to the expectation of a successful vaccine roll-out and resumption of economic growth. Stocks have continued to rally at least in part on the expectation of more government stimulus as the Democratic Party has gained control of the White House and both houses of Congress.
My outlook for domestic equities is about where it was at this time last year when I felt that equities were priced for smooth sailing. Stock valuations here in the U.S. are a bit of a concern with the S&P 500 trading near the same price to earnings ratio as it was at the peak of the Internet bubble in early 2000. However, when you consider that the 10 year Treasury at that time was yielding 6.5% (as of 12/31/99) versus a paltry 0.9% as of the end of 2020, stocks are inexpensive relative to bonds. One of the biggest risks to stock and bond prices would be a spike in inflation which would likely result in higher bond yields. Due to the inverse relationship of bond prices and yields, this would hurt bond prices. With regards to equities, equities become less attractive when bond yields are high. We are presently a long way from this, but a sharp rise in yields could cause concern among investors.
It appears we may finally be witnessing the Great Rotation in the financial markets. Large company domestic growth stocks have led the global financial markets for much of the past ten years, driven in part by a strengthening U.S. Dollar during this time. Expectations of a change in market leadership in recent history have proven premature. However, the outperformance of this segment of the financial markets has hit an extreme level, and it appears we are now seeing the beginning of what could be a durable period of outperformance for foreign stocks and small-cap, mid-cap, and value domestic stocks. The more attractive valuation of foreign securities versus their domestic peers and recent weakening of the U.S. Dollar further support the prospect of a change in leadership.
The current trend of lawlessness in our country is certainly disturbing. With the violent protests around the nation last year and last week’s storming of our nation’s Capitol, our country is more and more resembling a third world country. Whether or not this has an impact on our country’s financial markets remains to be seen. The valuation premium that U.S. financial assets have historically been awarded versus those of other countries could conceivably fade. Should this occur, the merits of a globally diversified portfolio could be further realized.
I wish you and your family a peace-filled new year. If there is anything we can be doing to help you, please do not hesitate to reach out to us.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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· The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The Bloomberg Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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