In 2020, global equity markets staged an extraordinary recovery from their March lows after COVID-19 nearly halted all economic activity and created the most uncertain environment since the Great Depression. Now, the path toward economic normalcy is underway as massive global monetary and fiscal responses, initiated quickly at the onset of the pandemic, provide needed liquidity and economic stability.
Economic conditions and corporate profit growth have steadily improved since the initial lockdowns of 2020, though both remain below normal levels. Even still, stock prices have surged higher—initially led by the tech sector and other stocks that benefited from the stay-at-home trend, and more recently by a broadening of the rally to more cyclical areas as investors received positive news about the rollout of COVID-19 vaccines.
The conclusion of the US elections also created more certainty around future policy initiatives and allowed for a bi-partisan agreement for further fiscal support to be reached. The additional COVID-19 stimulus package, as well as anticipation of future infrastructure spending, also contributed to the outperformance of the more cyclical areas of the market at year-end.
Below, we look at the major trends of 2020 and provide an outlook for 2021.
As medical progress continues to be made, the economy appears primed for continued economic recovery and growth. Restrained inflation, low interest rates, excess liquidity, and rising earnings provide support for stocks to trend higher for the broader market. That said, the following risks still exist:
- Ongoing political discord increased in early 2021 after a close run-off race in Georgia that flipped control of the Senate, riots in the US Capitol and elsewhere, as well as the impeachment of President Donald Trump.
- COVID-19 case growth remains high, and a headwind to the pace of economic growth.
- By many measures, valuations are stretched with the S&P 500 trading at 22-times forward earnings versus a historical price-to-earnings ratio (PE) of 16.6 times.
- There’s potential for some inflation as the economy reopens, where initial pent-up demand temporarily exceeds recovering supply, exacerbated by excess liquidity in the system. The potential for this risk can be seen in the steepening of the yield curve as well as in upward price moves in traditional inflation hedges, such as gold, and more speculative hedges, such as bitcoin.
Though the recovery has been impressive, it has been regionally uneven. US and Emerging Markets (EM) Asia equities have fully recovered from their COVID-19 losses, and then some, but other regions have only partially made up for lost ground. Likely this divergence is cause by sector differences between markets more so than regional-specific trends.
The US and EM Asia markets are heavily tilted towards the sectors that have done well during the pandemic—namely technology, communication services, and ecommerce. While other regions, like Europe, that are more heavily tilted towards cyclical sectors like financials, industrials, materials, energy, and consumer discretionary have lagged, with demand suppressed by the effects of the pandemic. As the economy recovers, it’s likely that some of these other regions may play catch up—a trend that has already started.
Additionally, after a decade of strength, the US dollar may be at a turning point. Rock-bottom interest rates, ballooning government debt, and a muddled economic picture have sent the US dollar to multiyear lows in 2020. Timing the exact start of a currency cycle is difficult, but if this trend continues, it could be the catalyst investors in global portfolios have been waiting for.
Some of these trends were seen in November when European equity markets had their strongest monthly performance ever, while Japanese equities hit their highest level since 1991. The weakening of the US dollar boosted returns in these areas for US dollar-based investors. Meanwhile, more defensive regions like the United States and EM Asia did well in absolute terms but lagged in relative terms.
Given the significant disruption to the US and global economies in 2020, it’s remarkable how resilient financial markets have proven to be. Markets have largely looked through the pandemic to the recovery. However, strong equity market performance during a period of softer economic conditions often brings the challenge of higher valuations. The first half of 2021 should answer many questions regarding our collective success in ending the pandemic as well as the pace and shape of US and global recoveries from the recession.
That being said, the global economy will likely continue to recover. Tight inventory levels, pent-up demand, and further policy accommodation may combine to generate a strong global economic rebound as virus conditions improve, though growth could return unevenly across regions as vaccines are distributed and made widely available.
There’s a case for outperformance in the more cyclical parts of the market—like financials, industrials, and materials—as the economy reopens. That said, strong secular trends will likely continue to be constructive for growth and innovation, too.
Information technology has become the new defensive sector, dependable in all market environments, and ecommerce will likely continue to proliferate as consumers have come to appreciate and expect the flexibility associated with online sales, same-day delivery, and pick-up and delivery services.
A sustained lower dollar may be a tailwind for global investing in the coming year, especially as valuations outside of the United States are attractive on a relative basis.
For all of these reasons, we guide clients towards geographic and sector diversification. Taking risk tolerance and investment objectives into account, we continue to advise clients to stay the course with a diversified portfolio and longtime horizon that can give more comfort in the midst of short-term volatility.
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If you have questions about the 2021 outlook and how trends might impact you or your investments, please contact your Moss Adams professional.
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