2020 was a strange year. A pandemic, the likes of which have not been seen for a century, claimed jobs, fortunes, and lives. At its height, nine of every ten economies around the globe entered recession. Not since 1870 has the world entertained such a synchronous downturn. The US lost 25 million jobs. The S&P 500 dropped 34% wiping out roughly $9.4 trillion in just 22 days. The VIX, a measure of market volatility, rose to a new all-time high. So did gold. West Texas Intermediate (WTI) oil futures went negative for the first time in history. None of these were normal. None were comforting.
But things improved. The Federal Reserve turned on the proverbial printing press and minted trillions of dollars to get the economy over the hump. M2 money supply, which includes checking and savings accounts, money market accounts, and CDs, increased by roughly $3.75 trillion in 2020. Last year saw the largest expansion in US money supply since WWII.
Reflation to the Rescue
But money printing didn’t come without consequence. The US $ Dollar experienced a noticeable decline. The US Dollar Index, which measures the greenback against a basket of six other major currencies, declined precipitously to finish the year down about 7%.
But a declining dollar helped fuel the year’s rally. A weak dollar makes US exports more competitive abroad. It also allows US companies to convert overseas profits back into US $ dollars cheaply. Both of these helped equity markets. The drop also helped spur a rally in Gold. The precious metal is priced in dollars and becomes more affordable to foreign buyers when the dollar falls. Gold set a new all-time high in August before giving back some of its gains.
The Fed didn’t just alter the money supply. Interest rates were slashed to their lowest levels in history. US mortgage rates hit all-time lows and refinancing transactions went through the roof. Housing boomed. Mortgage origination volume hovered near its peak at about $3.6 trillion. Estimates from Goldman Sachs suggest that refinancing options may exist for 50% of outstanding 30-year mortgage borrowers in 2021, which would be a boon for banks.
Bonds, Bonds, and More Bonds
Bonds also had a banner year as investors fled equities in March for safer pastures. Yields went negative in most major economies, the US excluded. (Bond yields are inversely correlated with bond prices. When money rushes into bonds it pushes prices up, which drives down yields. If the price rises high enough the yields can go negative. A negative yield means that the investor will lose money on the bond). The stockpile of total global negative yielding debt rose to $7 trillion last year. Danish banks issued negative interest rate mortgages. (We don’t fully understand how that works but we started shopping for Danish real estate anyway).
Markets responded to the stimulus. Governments around the world threw everything they had plus the kitchen sink at the economic crisis. It worked. US Equities rose sharply over the five months following the March drawdown. Most other developed economies charted a similar trajectory and a V-shaped recovery took hold. Markets rebounded to set new all-time highs. But this wasn’t a typical recovery.
Large tech companies led most of the upturn last year as we were all forced to go digital and work from home. The top five companies in the S&P 500 now comprise 22% of all equity market capitalization, which is staggering given the thousands of companies that make up this segment. Four of those five are tech companies. (Tesla just recently knocked Google out of the pack to claim the 5th spot). Collectively the top five returned 49% in 2020. Everyone else returned 9%. Most of the gains last year came from just one sector of the market, and within that sector less than a handful of companies. We’ve seen high levels of market concentration like this in previous cycles, but it isn’t the norm.
Jobs Are a Big Deal, Too
On the economic front, unemployment rose to its highest level since the Great Depression. Thankfully it edged back down into single digit territory by the years end. Somewhat worryingly, permanent job losses have increased every month since the March drawdown. Permanent jobs tend to pay more and are known to be harder to replace. Structural unemployment is likely to present a headwind for the next few years as the economy reshapes itself in a post-pandemic environment.
There was an Election
A slight blue wave took hold politically. Democrats claimed the White House and maintained a slim margin in the House following the November election. Control of the Senate was pushed to January with a Georgia runoff election. Equity markets surged nonetheless. Expectations of a divided Congress created perceptions of a “business as usual” environment – a well known variable. Markets had their best month in more than three decades following this. The Dow, S&P 500, and NASDAQ all moved upward by double digit figures for the month of November. The rally continued into December to finish the year strong. Sick people and a sick economy proved no match for decisive actions from the Fed.
In January, Georgia’s senate run off resulted in another two seats for the Democrats. This effectively gives them control of the senate through a tie breaking vote cast by the Vice President. Major legislative changes are possible, but passage may be more difficult than some anticipate. Democratic senators in battleground states may be hesitant to vote for sweeping changes that could see them punished at the polls. The Biden administration will need to expend its political capital carefully. Some sectors and individual names that ran up swiftly on a wave of optimism, such as green energy and EV stocks, could be in for a rude awakening if certain legislative priorities are stymied.
What’s Ahead for 2021
Estimates for global growth vary wildly. World Bank GDP growth estimates center around 3.4%. Goldman Sachs and JP Morgan forecast growth closer to 6.4%. The divergence is striking but indicative of the uncertainty that still remains around the economic impacts of COVID. Monetary and fiscal stimulus measures are likely to continue well into 2021 as a result.
Low interest rates are likely through 2021 and for some time thereafter. This will present a challenge for bond investors but will be accretive for growth equities. Housing should have a bang up year as well. The SPDR S&P Homebuilders ETF (XHB) is up 160% since its pandemic lows. Cheap mortgages, work from home lifestyles, and a desire to leave crowded urban areas are likely to buoy this sector through to the end of the year.
2021 will be a year of volatility. The rollout of a vaccine and continuing fiscal and monetary support will take the worst-case scenario off the table, but this doesn’t mean swift and short-term pullbacks won’t happen. Expect whipsaw like movements in many individual names and sectors. Some things will get bid up to levels that just don’t make sense. A bad news cycle will take hold and prices will correct. Investors with cash on the sideline (who are holding cash at historically high levels, btw) will buy the dip. Equity prices will find a floor and bounce back up. The relatively smooth ride we enjoyed in the 2010s is over. Volatility is back. Individual stock pickers will once again make a name for themselves. The average portfolio is going to generate performance figures that look like saw teeth. Buckle up!