Equity markets continued a torrid run in the fourth quarter, propelling nearly all sectors and asset classes back into the black for 2020. But Q4 was defined by a notable shift in market leadership as cyclical sectors and asset classes bested defensives and growth stocks. The backdrop for this shift was the continued broadening of economic growth as companies adapted to serve their clients even as COVID-19 intensified. The coronavirus is still advancing in the U.S., but a shrinking slice of the U.S. economy is absorbing the deepest impacts — namely travel, hospitality and entertainment. Headwinds to those sectors intensified in Q4 amid renewed lockdowns, but data show the remainder of the economy has remained resilient.


Numbers from the Institute for Supply Management (ISM) Purchasing Managers Index tell the story. Both manufacturing and service sector firms reported rising new orders against a backdrop of extremely constrained inventories. Low inventories and growing demand are a recipe for future economic growth. Importantly, the ISMs show that this potent combination is appearing in a broad swathe of industries. Manufacturers have adapted and activity is humming, while some service industries are still sluggish.

Simply put, economic growth is clearly broadening, and that in turn is boosting earnings, ultimately providing the backdrop for a more inclusive stock market rally.

The manufacturing and service sector indexes together track a total of 36 unique industries. Through the fourth quarter, 31 of these industries reported growth. During the height of COVID-19 uncertainty in April, just four industries in the ISM indexes were growing. Q4 was even a sharp rise from the 14 industries that reported growth at the end of 2019, when the trade war was still impacting the manufacturing sector. Simply put, economic growth is clearly broadening, and that in turn is boosting earnings, ultimately providing the backdrop for a more inclusive stock market rally.

For another perspective, let’s look at the 11 sectors that comprise the S&P 500 index of Large-Cap companies. At the end of Q1 — or peak COVID-19 uncertainty — not a single S&P 500 sector was positive. As companies adapted and stabilized in Q2, two sectors turned positive. That rose to six by the end of Q3 and ultimately to 8 of the 11 by the end of Q4. Notably, of the three sectors that finished the year in the red, two of the three — cyclically sensitive energy and financials — were the best-performing sectors in the fourth quarter. Investors were peering into 2021 and began positioning for a full and broadly inclusive reopening of the U.S. economy, driven by vaccines from Moderna and Pfizer/Biontech.


Heading into Q3, only defensive U.S. Large-Cap stocks were in the black, largely driven by names in the index that were deemed virus resistant. Conversely, economically sensitive U.S. Mid-Caps and Small-Caps declined 6 percent and 9 percent, respectively. During Q4 Mid- and Small-Cap stocks pushed ahead by a whopping 24 percent and 31 percent, respectively, to finish the year with gains. We’d also be remiss to not mention that International Developed and Emerging Markets experienced strong rallies that propelled them to yearly gains in Q4.


We see the economic broadening theme carrying over well into 2021. The U.S. and global economies are operating on multiple cylinders of growth for the first time since 2017, just before the trade war stifled manufacturing growth in the U.S. and abroad. In 2021, the U.S. economy should experience strong tailwinds from additional fiscal and monetary stimulus coupled with an end to the pandemic’s impact on the economy. Pent-up demand in industries impacted by COVID-19 (say, people eager to travel or attend a live concert or sporting event) and a needed inventory rebuild should further spur job growth. All together, these are conditions for above-average economic growth, and we forecast stocks will push higher, with more cyclical sectors and asset classes continuing to lead the way.

Keep in mind that we may have setbacks in the coming months as the virus continues to pulse around the globe. The market discounts more than a few months into the future, and investors have largely been viewing today’s challenges — particularly in leisure and entertainment — as temporary. Any knee-jerk reaction to a setback will likely be met with buyers who remain confident that COVID-19’s influence on the economy will only weaken as time passes.


The story of 2020 would not be complete without some commentary on the extensive fiscal and monetary policy around the world that helped bridge economies from the beginning of COVID-19 to its hopeful end in 2021. Indeed, one of the silver linings of the Great Recession more than a decade ago was that policymakers learned lessons and developed a playbook for the next recession. Most importantly, they learned to go big and act quickly. Those learnings were on full display during the recession of 2020.

Any knee-jerk reaction to a setback will likely be met with buyers who remain confident that COVID-19’s influence on the economy will only weaken as time passes.

Just as we forecast at the beginning of the COVID-19 recession, monetary policymakers responded quickly and fired multiple bazookas in March. Despite political division, fiscal policymakers swiftly followed and unleashed the largest non-war stimulus/relief package in the country’s history. And as the year closed, fiscal policymakers provided another round of support for businesses and citizens still impacted by COVID-19.

The impacts of these swift actions cannot be understated. They were decisive, and they helped turn the economic and market tide. Think about this: The U.S. economy, measured by GDP, shrunk in both Q1 and Q2, but U.S. personal income did not. Production or economic growth (think GDP) is essentially someone’s income. While GDP fell at an annualized pace of 5 percent in Q1 and 31.4 percent Q2, personal income rose year-over-year in 2020. Direct payments and stimulus achieved their purpose and filled the “production hole” left from initial and continuing job losses. Employees also came back online as companies could reopen.

Contrast this with the Great Recession: A small stimulus package a few months into the Great Recession helped plug the income hole, but it took nearly two years thereafter for personal incomes to surpass their pre-stimulus levels. As we head into 2021, policymakers are determined to not let this happen again. While there are still many individuals suffering from COVID-19-related job losses, in aggregate, the U.S. consumer enters the year with a relatively high level of savings. What’s more, the cost of servicing debt (historically low interest rates) is the lowest it has been since the 1980s. These factors, along with an improving labor market, are catalysts for a release of pent-up consumer spending in 2021, which is a major driver of economic growth.

Although the events of 2020 may indeed be once in a lifetime, ultimately the biggest determinant of investor returns in 2020 was the same as it ever was: Were you able to withstand the urge to do something when others panicked?

We believe both monetary and fiscal stimulus will remain extremely supportive of the economy and markets for years. The Federal Reserve has shown that supporting markets is a key component of its economic policy. As we wrote in our Q2 commentary, the Fed’s Quantitative Easing Program (QE) was designed to encourage investors to replace their safer assets with riskier assets. And we note that the Fed is committed to this policy well into the future. During 2020, the Fed “institutionalized” its desire to let the economy run hotter longer than it has in the past. The “Old Fed” tightened policy gradually as core inflation moved toward 2 percent. The “New Fed” will not even contemplate tightening until inflation is well above 2 percent and has been for some time. Some may worry the Fed has exhausted all means to stimulate the economy, but many of the Fed’s accomplishments last year simply required an announcement of intent but not necessarily an action. Looking ahead, it’s interesting to contemplate deeper policy “coordination” that will likely occur between current Fed Chair Jerome Powell and former Fed Chair (and Treasury Secretary nominee) Janet Yellen.

Fiscal policy will also remain supportive into 2021. Democrats will control both chambers of Congress and the White House, making additional stimulus highly likely. Keep in mind that while Democrats have control, it is by a slim majority, which makes an extremely progressive policy agenda unlikely to gain traction (aggressive stimulus and aggressive tax increases are unlikely). Regardless, it’s a good time to reiterate our belief that the occupant of the White House is neither an absolute positive nor absolute negative for the economy or markets. Our research shows that the stage of the business cycle when a president takes office is a better leading indicator of market returns under the president’s watch. At this point, incoming President Joe Biden will assume office as the U.S. economy exits a recession and is early in its business cycle.

There are certainly risks to our policy outlook. However, we don’t believe policymakers will change their accommodative stance until there is a visible cost to be paid on the other side. Currently, both fiscal and monetary policy actions appear to be free of cost. We believe one of three things will need to happen for a cost to become evident: a sharp dollar decline, an inflation surge or investors deciding that interest rates are insufficient compensation for the risk of owning bonds. Currently, investors are buying Treasurys with yields lower than inflation, which is already low. While we are comfortable with these risks in the nearer term, we do believe that these, along with potential corporate and individual tax hikes, could cause market consternation later in 2021.


The best-laid plans for 2020 were all upended as the pandemic worsened. This isn’t an uncommon occurrence for investors. Unfortunately, unexpected events so often tempt investors to believe that “this time is different” and react emotionally by selling. While COVID-19 was new and “unique,” how one processed it shouldn’t have been. Although our 2020 outlook shifted in February, it did not change our overarching investment philosophy and thinking around secular themes. At our core, we remain long-term investors.

Now that economic growth is broadening, we believe a rotation into less popular asset classes will continue into 2021.

Quite frankly, the only thing that mattered in 2020 was whether one believed policymakers could bridge the economic and market valley caused by COVID-19. Regular readers of our commentaries know that we repeatedly expressed our confidence that policymakers would arrive quickly to bridge the gap and would continue to respond when needed. That’s precisely what has happened and will continue to happen. That doesn’t mean there won’t be unexpected shocks that cause market downturns, but we do believe they will be shorter in duration — like what we experienced in 2020. As we stated, this will be the case until there is a “cost” for policy actions — something we will continue to look out for in 2021.

Although the events of 2020 may indeed be once in a lifetime, ultimately the biggest determinant of investor returns in 2020 was the same as it ever was: Were you able to withstand the urge to do something when others panicked? Did you remain calm or even increase your equity allocation during the swift decline into a recession?

Those who sold in March during the depths of despair missed a historic recovery — and opportunity. This is not a new concept; we have written extensively about the returns missed by those who sell when others panic. Stocks are risky, and that’s why not everyone can own them. Those who sell when downside risk becomes painfully evident create the excess returns for those who can hold, or even buy, during periods of market stress.

This became vividly clear for those who panicked and sold in 2020. Since the market bottomed on March 23, U.S. Large-Cap stocks have returned 70 percent, while Small- and Mid-Cap stocks returned 91 percent by the end of 2020. Even our broadly diversified, balanced account (based on a benchmark rebalanced monthly) of 60 percent equities and commodities and 40 percent U.S. investment-grade bonds returned nearly 40 percent. This is nearly five years of expected returns at 7 percent compounded per annum. If you don’t think you will be able to hold when the “stuff” inevitably hits the fan again, it’s time to review your plan with your advisor now, when times are good, rather than waiting for the next market downturn to occur.

Our last plea is a similar one. Returns for the past few years have been dominated by U.S. Large-Cap growth stocks. Now that economic growth is broadening, we believe a rotation into less popular asset classes will continue into 2021. We are not suggesting growth stocks are not good long-term holdings, just that there are plenty of other less exciting stocks and asset classes that should benefit from broader economic growth in 2021. We believe the next few years will be economically different than the past and even hazard an outlook that, at some point, we will be worried again about rising inflation and possibly even interest rates.

Happy new year, and all the best.

Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. To learn more, click here.

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