QUARTERLY MARKET UPDATE as of January 2021
The stock market had another strong quarter with the S & P 500 gaining 12%, and ending the year up over 15% on a remarkable recovery from the crash in March. Last spring’s coronavirus fueled bear market was the shortest in history. For the fourth quarter, every sector was in positive territory led by very solid gains from the beaten down Energy and Financial sectors, both were up over 20%. Small Cap and International Stocks also surged, with the Russell 2000 Index advancing 31%, and the MSCI EAFE index gaining 16%.
Intermediate and long-term interest rates have started to increase as the economy gradually recovers. The 10-year Treasury note ended the quarter about ¼ point higher at 0.93%. On the short end of the yield curve, the Federal Reserve Bank will maintain its easy money policy keeping the range on the Federal Funds rate between 0% and 0.25% until the labor market fully recovers.
The unemployment rate has continued to decline, now at 6.7% compared to 14.7% last April. We expect that rate may stall over the next few months as the recent holiday lockdowns for containing covid-19 will impact the recovery in the short run. For many the economy is still in shambles. The hospitality and service economy has suffered greatly, and jobs at many brick and mortar retailers may have been permanently lost. The evidence is obvious walking through many downtown areas with closed restaurants and shops. As we move through winter with many lockdowns indefinitely in place, we may see more closings and bankruptcies.
Yet the financial sector, especially large banks, have been deemed well capitalized by the Fed and have adequate funding to cover expected bankruptcies. Over the last year, banks set aside over $100 billion in loan loss reserves, and government stimulus checks last spring as well as the next batch coming out soon will actually increase Americans’ overall income.
2021 brings a unique dichotomy of optimism and caution. On the positive side after nine months of staying mostly at home, there is a pent-up demand for goods and services which we expect to drive growth this year. With an accumulation in savings accounts since the start of the pandemic of over $2 trillion dollars, consumer spending will have an ample supply of cash.
Two vaccines in the U.S. have already been approved with more expected this quarter. The logistics will improve and ramp up for millions to receive their first dose in upcoming months. A combination of vaccinated individuals and those that have already had covid-19 will likely slow the spread of the virus. This should allow schools to reopen and children’s parents to return to work. Businesses will progress to more normal times ahead, and low interest rates will keep borrowing costs down for both companies and consumers.
For the first quarter though, we are cautious about near term growth. The raging pandemic will almost certainly reduce growth this quarter. Forecasts vary widely ranging from a modest slowdown to negative growth and another recession. But in any case, we will most likely see the economy improving towards the end of March, with this month being the slowest. Also, the Georgia senate runoff election may have more of an impact on market perception than the economy in the short run. Historically a divided government means more stability, and less uncertainty over long term policy changes.
The increased money supply and expected splurge of consumer spending this year also makes us concerned about potential inflationary pressures. Higher inflation may push longer term interest rates up. Government debt refinancing and a weaker dollar may also put upward pressure on yields. The Treasury rate is still under 1%. It is not hard to imagine a more normalized interest rate environment with a T-note yield at 2%. That yield places downward pressure on growth stock valuations. Growth stocks have benefited from the low and declining interest trend over the last decade. Higher interest rates impact present values and have a more negative impact on growth stocks than dividend paying stocks.
As the economy recovers, we expect to see a greater performance difference going forward in stocks that are still off of their 52-week highs versus the stocks that have already soared. Many high-quality dividend paying stocks are just starting to rebound. This includes stocks in the Financial sector that will benefit from a higher 10-year yield and steeper yield curve. As valuations are also more reasonable in many international markets, we expect to add to our international stocks. The recent dollar weakness will also be especially helpful to emerging markets.