Year in Review – 2020
Given the monumental impact of the coronavirus disease (COVID-19), it is virtually impossible to discuss the twelve-month period as a continuous one. It’s more sensible to think about the world before COVID-19 (to be referred herein as BCV) and after (ACV). For our purposes here, we will define that demarcation point as the middle of February, when investors woke up to the cataclysmic impact the disease would have on the economy. There is little one could say about BCV that would be applicable to ACV.
BCV the focus was on issues such as: impeachment, Brexit, presidential primaries, and trade wars and truces. In the world of ACV, the issues are starker: 1) individual health and 2) the 2020 elections, and 3) national and global economic survival.
The BCV economy was positive for the American economy and consumer, although growth slowed noticeably as the year wore on. Purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as unemployment fell to levels considered impossible just a few years ago. Federal Reserve rate cuts buoyed investor confidence.
ACV the economy went into a coma before a partial recovery during the summer. The recovery strengthened before weakening late in 2020 as the virus outbreak worsened. Official statistics are lagging indicators, but we know that perhaps 20 million Americans lost their jobs before the end of March. Many others continue to face an uncertain future. Many jobs returned over the last half of 2020 although overall employment was far below the BCV levels, as roughly half the lost jobs were restored. Many sectors of the economy remained surprisingly resilient as the shift to the stay-at-home economy spurred the housing market and enhanced use of technology.
Major Economic Events
No nation was able to escape the impact of the COVID-19 disease. Hardest hit have been the US, Italy, Spain, Brazil, and India. Commodity producers have also suffered as demand vanished overnight.
The Federal Reserve, the US government, and governments worldwide have scrambled to deploy every tool at their disposal to keep economies afloat until the disease becomes better understood, better treated, and perhaps preventable via development of a vaccine. Levels of borrowing have already reached levels not seen since World War II and seem likely to rise from here. We can assess that the governmental actions placed a floor under the economy and provided much needed stability, even though the cost has been monumental.
As if things weren’t bad enough for the energy sector due to the collapse in demand, Saudi Arabia, Russia, and the US decided this would be a good time to fight for market share. Prices plummeted, and although this can be good news for consumers and resource-poor nations, it was devastating to oil-dependent economies such as parts of the US and energy producers globally.
The Equity Markets
Global stocks plunged in the first quarter of 2020, erasing all gains from 2019. Stock markets staged a stunning reversal even as economic levels plunged to unprecedented depths. For the year global stocks actually rose by over 16%, with many markets ending the year at record-high levels.
Stock markets were particularly susceptible going into 2020. Profits had stagnated throughout 2019 and the stock market gains of 2019 could be categorized as a triumph of hope over reality. ACV, profits have diminished drastically. The stock market surge in recent months has left the market at valuations rarely seen as investors are expressing unbridled optimism about future profits. Companies and sectors seen as beneficiaries of the work-from-home environment have seen their valuations skyrocket. Trust that the Federal Reserve will continue its zero-interest rate policy along with confidence that more help will be coming from Congress and the White House further boosted confidence. Progress on vaccines and hope about the post-covid environment added fuel to the speculative fires and propelled nearly every sector higher.
The American stock market performed far better than its international counterparts. The US economy did fare relatively well compared to other nations, particularly Europe. The US outperformance is also due to the dominant market position of the US technology sector. International markets rose by just 10.7%, a gain that pales in comparison to the US, where stocks rose by nearly 21%.
Although long-term investors in small and mid-cap stocks have been rewarded for the elevated risk and economic sensitivity of these firms, there is no doubt this has been an extremely difficult period. In 2019, rising labor costs and a slowing economy hampered smaller firms. The COVID-19 induced economic collapse impacts smaller firms more severely as they have less ability to weather a deep downturn. Government policies and interventions have been largely directed to the larger and better-connected firms. Small cap stocks underperformed badly until news of vaccine breakthroughs restored faith that economic recovery would happen in 2021. The fourth quarter of 2020 saw small and mid-cap stocks record breathtaking gains.
There was a large divergence between growth stocks and value stocks in 2020. Growth stocks, particularly the large-cap tech stocks, benefited from strong market positions, a dearth of competition, and the impact of the pandemic. Additionally, investor optimism about these equities reached astonishing levels and this further increased stock prices. Value stocks (banks and commercial real estate, for example) were severely hindered by the economic plunge and affiliations with the pre-covid economic landscape.
Natural resource stocks tracked the price of oil and collapsed in 2020 when demand vanished, and suppliers flooded the market. REITs were very hard hit in 2020 as the future value of much commercial real estate has come into question. Both of these asset classes snapped back later in the year but only managed to retrace a portion of the earlier losses.
Overall, the effects of diversification from the traditional S&P 500 index were negative. Small and mid-cap stocks ended with gains slightly above the S&P 500,while every other major asset class fell short of the S&P 500, in some cases by large margins.
The Fixed Income Markets
It was a strong year for US bonds. Prices rallied as the Fed cut rates during 2019 and then slashed rates to zero percent in response to the crisis. The broadest index of US investment-grade bonds rose by nearly 8%. Municipal bonds fell during the worst of the covid crisis but managed to recover and ended with modest gains. The collapse of tax revenues plus the strains of coping with the health crisis are placing major strains on state and local budgets. Markets seem convinced that the federal government will eventually support the finances of states and local governments. The election results have increased the likelihood of significant federal support. International bonds rose, as interest rates continued to descend worldwide. The dollar tumbled late in the year and this also boosted the value of non-dollar bonds. Cash and similar investments seem destined to remain at rock-bottom levels, in alignment with Federal Reserve policy.