Winter 2020/2021 Market & Economic Commentary
2020 certainly was a yo-yo ride in so many ways. The first and most amazing was the catastrophic collapse and rebound in global equity prices (as well as many other risk and even not so risky assets). Depending on the index, stock prices fell 30%-50% in just five short weeks as the world realized that we were in for quite an economic storm. Although dramatic, this was somewhat understandable, as an unknown virus exploded into a full-blown global pandemic in just a few short weeks. With it, governments (and populous behavior) responded by bringing the previously healthy global economy to a screeching halt. In the U.S. alone, over 20 million jobs were lost or furloughed in less than a month’s time. However, as companies adapted to conditions and governments responded with unprecedented stimulus (nearly $9 Trillion collectively in the U.S.), we found a way to limit the destruction and start clawing our way back to life, maybe not as we knew it, but life. By the end of the year, almost every major index had recovered all its losses, credit liquidity was restored, and even jobs came back far further than even the most optimistic expectations had hoped for.
Even the virus itself went on a yo-yo ride, first exploding on the scene, then receding as summer began, only to reaccelerate from the late summer into the end of the year, with numbers far more terrifying than most had feared during the virus’s initial onslaught. Certainly, most of us had our personal ups and downs – both emotionally and in circumstances; and sadly, some with tragic outcomes. One cannot acknowledge the collective tragedy enough. In reflection, 2020 was in so many ways a year like a yo-yo… going up and down and back again. And so far, 2021 doesn’t feel much different.
How the Markets Fared
Stocks may have gone on quite a ride in 2020, but they were by no means the only financial instruments that saw wild action. The bond market proved to be quite volatile as well. When fear struck global markets, interest rates on Treasuries plummeted to 0.5% from 1.91% to start the year. But broader interest rates, in general, weren’t down. Quite to the contrary. As the flight-to-quality trade rushed into the perceived safety of U.S Treasuries, most other debt instruments saw buying evaporate. Not only were credit-sensitive bonds, like high yield caught in a pricing-downdraft, but higher quality paper from A-rated companies saw their yields rise over 300 basis points. With no buyers, liquidity dried up and prices became mind-bogglingly low. This displacement was relatively short-lived as the Federal Reserve stepped in and essentially guaranteed a market for almost all traditional debt instruments, including junk bonds. This unprecedented move in the final days of March added much needed confidence and higher quality paper snapped back in price. Credit exposed debt rallied as well but would require the remainder of 2020 to get back to pre-Covid pricing.
Action in the final quarter of the year was rather muted in the high-quality end of the fixed income markets. As optimism built on the economy’s ability to recover after the November announcement of not one, but two vaccines, interest rates actually rose, with the bellwether 10-Year Treasury yield climbing to 91% at year’s end. That confidence did impact the more credit sensitive end of the bond markets, leading to over 6% in gains in high yield bonds, resulting in over 7% net gains for the year. This is remarkable. The dollar, which had skyrocketed in Q1 when Covid broke out, saw steady declines in the remaining three quarters of the year. This resulted in returns in both developed and emerging market debt to net similar results to those of high yield paper.
In any normal year, the action in the fixed income markets would have stolen the headlines. But it was equities that saw the craziest ride of my 30+ year on Wall Street. In the few weeks following Covid-19 being declared a pandemic, the S&P 500 fell over 30%. What was more remarkable was that the losses felt in the Value-end of the Growth/Value spectrum were far worse than growth names that were dominated by technology and certain consumer goods companies.
Traditionally, value-oriented stocks do better in market corrections, due to their more reasonable valuations (Price to Earnings and Price to Book ratios for example). However, this time, these were the areas of the market that were most affected by the seizing of the global economic engine. Banks stocks crashed in fear that their loan portfolios would suffer massive losses, cyclical companies that were sensitive to material costs and manufacturing understandably fell under massive selling pressure. Finally, energy companies bore the largest brunt of the Covid-led halt of the economy.
With everyone staying at home from work and play, and what few airplane routes that were still flying going out mostly empty, oil reserves filled to the rim and then literally began to run over. On one of the strangest days of my career in May of 2020, the price of a barrel of oil went negative. If you had a swimming pool or even a large fish tank, you could have been paid $37 per barrel if you would take delivery of oil that had run out of a home. A once valued commodity that was the lifeblood of American society had momentarily turned into toxic waste.
These more conservative investments that would normally preserve capital in a market swoon took the brunt of the Covid-selloff hit. Large Value stocks sold off nearly 40% at market lows. Small cap value stocks fared even worse. At least the larger value names like Bank of America and even Delta Airlines would likely be able to find financing or bailouts to get them through the storm. But smaller companies with less access to capital were fighting for their proverbial lives. The Russell 2000 Value index fell almost 50% from its early February highs to its March lows.
However, once the Federal Reserve stepped in with seemingly unlimited support for the U.S. financial markets and Congress passed a nearly $3 Trillion stimulus bill, equities began to rebound. But for the following seven months, growth stocks, that had weathered the storm so much better than value-oriented names continued to lead. As Covid raged on, these technology names that were not as hard hit and in many cases advantaged but the pandemic soared. In fact, many doubled, tripled, and beyond. At the close of the third quarter, the Russell 1000 Growth index had not only recovered all of its losses for the year but had gained 24.3%. The Russell 1000 Value was still down over 11.6y% and the small cap value stocks were priced 11.5% less than they had started the year.
But all that would change the week after the election (and no, we aren’t even going to rehash that joyous topic). On November 9th, Pfizer announced that they had a vaccine for the cause of all of this calamity. And it wasn’t just a good vaccine… it reportedly was a great one. That news was like the starting bell at the Kentucky Derby, releasing the pent-up value stock horses, and boy did they run. In just the final seven weeks of the year, the lonely small cap value stocks, that had fallen so far behind the pack, burst forward, adding over 33% to their value for Q4. This was triple the return of the inflated large cap growth stocks, enough to bring the Russell 2000 Value returns positive for 2020. Remember, they had lost nearly 50% at the market lows. That means that in the final nine months of the year, small caps stocks nearly doubled to regain positive territory. However, that wasn’t nearly enough to catch the pack. As the equity-horses galloped across the finish line for this remarkable year, large cap growth stocks still won the race, with the tech-heavy Russell 1000 Growth index finished this yo-yo of a year up a staggering 38%, to take the prize.
Small cap growth stocks made it a race down the stretch, rallying almost 30% in the final quarter of the year to finish with nearly a 35% return. Emerging market stocks in Asia took third for the year; but it was Latin American EM stocks that had the most impressive returns for the Fourth Quarter, rebounding an impressive 35%. However, those resource focused economies were hurt so badly in the beginning of 2020 that even Q4’s surge was not enough to keep them from losing 13.5% for 2020 as a whole. Commodities in general also posted a slightly negative year despite rising over 10% in Q4. Developed market international equities finished somewhere in the middle of the pack with a strong Fourth Quarter. There, as in the U.S., growth sectors outperformed value-oriented stocks by over 20%, despite value leading across the board in the last quarter of this wild year.
A peek at the numbers
Below are the key indicators that we are watching and what they are telling us.
- The labor markets are still soft but continue to improve, with unemployment down to 6.3% and the U6 measure for unemployed and underemployed workers down to 11.1%. We’re still about 10 million full-time jobs short from a year ago. Until social restrictions ease, food service, hospitality, travel, and leisure will struggle. However, those with jobs are enjoying better than 5% wage growth.
- The housing market is hot-hot-hot, except where it is not-not-not. If you aren’t in the downtown of a major city like New York or San Francisco, you’ve likely seen your home value go up lately. The more rural, the bigger the climb, with U.S. housing prices up 9-12%.
- Stock market strength, home price increases, and wage growth (for those whose fortunes are not directly impacted by Covid) should be leading to consumer confidence… they are not. The conference board reading of 89.3 is among the lowest since Covid hit. This may be why we are seeing the personal savings rate climb to a miserly 13.7% of income. In 2007 it was negative!
- Business-to-business activity continues to improve. The ISM Report on Business shows both manufacturing and services are continuing to expand. Both readings came in at 58.7% for January (with readings above 50 indicating expansion).
Besides being a fun and sometimes addictive toy popularized by the Duncan company in the 1030s, “Yo-yo” became a slang term meaning someone who is acting stupid, eccentric, and even crazy (as in “that guy is a real yo-yo”). Here too, the term applies to 2020. Whether you believe we will fully recover from the virus economically in short-order or not, it is hard to rationally justify record- breaking highs in the stock market. It is further difficult to ignore astronomical valuations that are approaching, and for some indicators, exceeding 1999’s bubbly valuations.
Just like 1999, retail and often novice day traders are claiming fortunes and companies that make little to no revenue are trading at 50-100 times their theoretical earnings… five to ten years from now! But with the word Zoom going from a 1970s children’s TV show to a verb used in every American company and household several times a day, clearly, some of these companies will justify these lofty valuations. But if the Y2K/dot-com pattern repeats itself, for every Amazon success story, there will be hundreds of dot-gones and eventually deflated market valuations to be reckoned with. With valuations of U.S. companies 30% to 100% above their long-term norms, the E (earnings) is going to have to grow fast, or the Ps (prices) are going to come tumbling down.
The bulls say that consumers who have been hoarding cash (see personal savings rate above) will be spending it in waves when they unleash their pent-up demand in a post-Covid world. The bears say that when this unprecedented stimulus runs out and the 9+ Trillion dollar bill comes due, that markets will correct, or worse. At North Pier, we can only add some PIERspective on these crazy days. Which way the yo-yo will move next, up or down, remains to be seen.