INVESTMENT QUARTERLY

2020: THE YEAR THAT WASN'T

Who could have ever imagined we would have to live through a year like 2020? The economic  impact of over 23 million individuals losing their jobs, over 50% of restaurants being either  temporarily or permanently closed, airlines and hotels operating at a fraction of full occupancy,  with people feeling trapped in their homes for safety, couldn’t have been imagined in our wildest  hallucination. The second quarter of 2020 offered a horrendous economic result and despite a  strong rebound in the third quarter, the fourth quarter will, although positive, leave us with a  negative GDP for the year. The results will likely be the worst year since 1946. For 2021 the  consensus seems to be just over 4% growth. Goldman Sachs is far more bullish with a recent upward revision to a plus 6.6% forecast, albeit with some significant caveats. Interestingly, their  concerns are primarily COVID-19 related, but not significant enough to temper their projections. 

Looking back at 2020 it seems that economic results hardly influenced the market at all. After the  initial COVID-19 scare in the first quarter, the market took off like an Elon Musk rocket and ended  up 9.7% on the Dow and 18.4% on the S&P 500 for the year. The difference between the two  indices is due to the impact the FAANG stocks had on the S&P average. The construction of the  S&P 500 average results in the FAANG stocks having a 25% weighting and their extraordinary,  combined performance greatly influenced the final S&P average. 

The major cause of the stock market’s performance in 2020 was the fiscal and monetary policies  of the government. The Federal Reserve continued its Quantitative Easing Policy of adding  liquidity to the market through its monthly purchases of government securities. Congress added  to this through its broad-based financial program for business stimulus and restrictions on  evictions for failure to make rent or mortgage payments as well as other support. Additionally,  some of the unemployed were enjoying greater income than when they were employed. This  made it hard to call back laid off employees, particularly in the service area. All this was not  sufficient to comfort the worried citizenry. With a great deal of consumer insecurity, much of this  government largesse did not end up in the economy but did stimulate the stock market. With  bond yields at record lows, the only attractive investment opportunity left was the equity market.  The result was a market that soared to higher price earnings ratios despite significant declines in  earnings of the underlying companies. With dreams of additional stimulus and increased  spending by the Biden administration the market has continued to move to new highs early in  2021. 

The Biden economic plans look to be a combination of selected industry disruption, an increase  in corporate and individual taxes, and dramatic increases in spending for new programs, as well as economic stimulus payments to perk up a slowing economy. US government debt, already at  highs, will probably set new records as politicians are no longer afraid to go to the well to fund  new programs. Biden will have two years with control of both the House and Senate, although  he will have smaller margins than prior administrations. So, the success of the progressive  overhaul may not be as easily accomplished as originally thought. 

The argument for renewed stimulus by putting cash in citizen hands raises some interesting  questions. In recent rounds the stimulus funds have been evenly split amongst savings, paying  down debt, and actual spending. The immediate economic benefit of a debt dollar used for  stimulus is now only thirty-three cents under this scenario. The stimulus does not have a  multiplier effect. In earlier periods a dollar of debt would multiply to three dollars of economic  benefit. This decline in efficacy is the predicted result of a significant increase in debt financing  of our economy. A second measure of an increasing, but less effective, money supply is the  continuing decline in the velocity of money. The decline in velocity to new recent lows reflects  the ineffectiveness of pumping more money into the economy. The US needs to find new policies  that will have a more direct effect on the economy if we are to work our way out of this situation. 

Speculation is on the rise and is reminiscent of the late 2000s as the dot.com dream became a  nightmare. Stimulus money ending up in the market because there is no demand for it in other  areas has elevated prices to very high and risky levels. New trading platforms, like Robinhood, have brought new, unsophisticated investors into the game resulting in unprecedented and  unwarranted price action of some nearly bankrupt companies. At some point these speculators  are going to painfully lose, like speculators in similar periods of investment history. The  speculators actions can affect the overall markets and, through imbalances they create, cause  the markets to crater. Hopefully, this trend will end before it overwhelms fundamentally sound  investment activity. With markets already forcing investors into riskier investments to get  acceptable returns, any additional speculative action could have a significantly negative impact  on the markets and investors. 

In summary, it looks like COVID-19 and its variants will control the outlook for the markets for a  good part of 2021. The variants of the virus that have already started to move around the world  will likely take longer to get under control than the original. The longer it takes, the harder it will  be for the world’s population to get back to normal activity, and the more stress our already  weakened and debt laden economies will have to endure. I think the recovery will happen but  more slowly than Goldman Sachs is predicting. Even with a bright forecast for 2021 Goldman is  looking for a significant decline in 2022, followed by a further decline in 2023. Successful investing  will require analysts to pay close attention to earnings progress and balance sheet development. 

In 2020 the Dow returned 9.7%, the S&P 500 18.4% and the Russell 3000 20.9%. The Bloomberg  Barclays US Government/Credit 1-5 yr. index returned 4.7%. All these returns came in the face of  a poor economic year but with a huge financial stimulus from the Government.

Robert B. Needham, CFA