Winter 2020/2021 Quarterly Commentary
Economic Perspective
Goodbye, 2020! Hello, 2021!
The economic recovery in the United States continued its ascent during the fourth quarter. The COVID-19 lows of March through May seem a distant past when compared to the sharp rebound in manufacturing and solid growth in the service sector.
The ISM Manufacturing Index in December experienced its 8th straight month of growth. It posted an impressive 60.7 reading – strongly above the 55.4 level three months prior. The ISM Services (Non-Manufacturing) Index, representing approximately 75% of the American economy, recently retreated from 57.8 last quarter to 57.2 at year-end. The plateau seen in the ISM Services data is understandable given the spike in COVID cases and the uneven geographic reopening of our economy. As a reminder, any reading over 50 represents economic growth whereas under 50 represents contraction. We believe these indexes remain good barometers to gauge the underlying strength of the economy.
Consumers continue to adapt to the new reality of less brick-and-mortar shopping and more online digital shopping. Amazon, Costco, Target and other ‘big box’ retailers continue to benefit from this ‘new normal’ with their holiday sales recently going parabolic. This has been at the expense of many smaller local businesses that have been forced to temporarily, or permanently, close their doors due to pandemic restrictions. While we are encouraged by increased retail spending via the digital channel, we are quite concerned that Main Street America may never look the same. This could be a headwind to future economic growth. Hopefully, increased vaccine(s) distribution throughout the first half of 2021 will alleviate some of the pressure that small businesses have experienced over the past year – provided they can survive until then. Our fingers remain crossed.
With the presidential election in the rear-view mirror, there are several economic implications to consider. Short-term, income replacement stimulus, providing additional direct consumer support ($600 – $2000 per person), should propel economic growth higher. Later in the year, a package of infrastructure and alternative/green energy stimulus could be offset by higher corporate and capital gains taxes. This has us somewhat cautious. We realize, however, higher taxes could be viewed favorably by Wall Street in that Washington D.C. is finally trying to pay for its spending! Obviously, the devil is always in the details. We will be watching closely!
Market Perspective
We are keenly aware that, no matter the outcome, half of the country was going to be greatly disappointed post-election. With that said, we believe there are investment opportunities under any administration. We have identified the following possible market positives. First, a pivot under this administration from nationalism / populism towards globalism could result in stronger growth and trade. This should benefit multinational companies with material international exposure in the tech and healthcare sectors. They have been two of our favorite sectors for some time now due to their innovation, disruption and favorable population demographic trends. Second, with the new administration stating, “America is open for business!”, we could experience increased foreign investment flows and direct investment. With U.S. interest rates still positive (and rising) versus the rest of the world, the influx of new money from abroad could be significant. This would help support the U.S. dollar and sustain our economic recovery. Third, if Jerome Powell remains Fed Chair, we believe he is the one person who can directly impact the economy and the stock market – much more so than any president or new administration. Over time, monetary / interest rate policy has been much more consistent & potent than fiscal policy out of Washington D.C. which tends to be more sporadic & oftentimes temporary. In addition, we are also encouraged that Powell’s Fed Chair predecessor, Janet Yellen, will most likely become the next U.S. Treasury Secretary. A Powell-Yellen pairing would be a formidable duo with pro-growth, pro-market experience to help us navigate the markets in the coming years.
As pragmatists, we believe it is prudent to keep our optimism in-check as we await clarity (and cost) on policy coming out of Washington D.C. We remain concerned about the rise in America’s indebtedness – currently $27.56 trillion at year-end (up $4.36 trillion in 2020). As the economy continues to improve, we expect interest rates to grind higher. This increases the servicing cost on that debt. A normalization of interest rates (higher) is typically viewed favorably if it is not accompanied by higher inflation. Our base case is that inflation will remain in check – but the last thing our slowly opening economy needs is Powell and the Fed to change monetary policy from accommodative to restrictive to combat inflation.
Bullish investor sentiment is waving a yellow flag. Most historical valuation metrics for the stock market are trading near multi-year highs. History suggests that these levels can persist if fundamentals (i.e. – revenue & earnings growth) ‘catch up’ to valuations in the coming quarter(s). This would be very healthy for many companies that have experienced strong, V-shaped recoveries. So, while the market is not priced-for-perfection, we see it as richly valued and feel a lot of good news is already priced in. However, it is important to remember, high-quality dividend-paying stocks are still in demand and likely to remain supported by foreign investment flows, allocation shifts from bonds to stocks, dividend increases, stock buybacks and increased merger-and-acquisition activity.
Looking Ahead
We are entering a seasonally strong period for the market. Historically, the market’s strongest returns happen between November 1st and May 1st. This keeps us constructive on stocks over the near-term as post-election money-on-the-sidelines, employee bonuses and tax refunds oftentimes enter the stock market during this period. Over the intermediate-term, our persistently low interest rate environment has us overweighting stocks over bonds. However, we are careful not to paint with a wide brush. Focused sector and stock selection will remain vitally important in our ever-changing world. While we believe 2021 has the potential to be a strong year in the market, we would not be surprised to see a market pause or short-term market correction at some point during the year. Time will tell.
