What 2020 Means for 2021

What 2020 Means for 2021

The year 2020 was extraordinary.  It was a year marked by a devastating virus, a Gepression (government shutdown of the economy in response to the virus), and unpreceded policy responses, the likes of which have never been seen before.  Moreover, the harnessing of the healthcare resources to produce treatment options and vaccines were nothing short of remarkable.  As we enter 2021, COVID-19 infections and hospitalizations are rising, and the full effects of the holiday season are yet to be felt.

However, vaccine production and distribution are increasing, and a critical inflection point may be only weeks away (peaking of the infection rate and an acceleration in vaccine distribution).  Unless government restrictions accelerate and more businesses begin shutting down, the economy should continue to respond to the unprecedented degree of fiscal and monetary stimulus that has been employed since March of 2020.  The most recent stimulus package of $900 billion should help reaccelerate economic growth which has recently begun to slow.  The ADP Report on employment showed a decline in employment of 123,000 for the month of December and the non-farm payroll employment report recorded a 140,000 decline with an upward revision of 135,000 for the prior two months.  At the same time, the ISM Purchasing Manager Index for Manufacturing showed a strong rate of 60 for December.

The economic and financial markets’ landscape is likely to experience unusual twists and turns as health concerns ebb and flow.  Certainly, there is a forecast for every occasion, as well as an enormous preoccupation with short-term developments.  Ultimately, financial market behavior and results, however, will be influenced by fundamental developments that play out over the intermediate and longer term.

Despite all the political rhetoric, the handicapping of the elections, the crisis in the Capitol, and doomsday scenarios, a multitude of factors are in place to foster continued economic growth and the accompanying recovery in profitability.

The fiscal stimulus ($900 billion) just enacted and the likelihood of additional spending ($600 billion) under the new administration are meaningful percentages of GDP.  Further into the new year, an infrastructure plan is likely to emerge, providing additional fiscal thrust.

On the monetary front, the aggressive level of monetary accommodation provides the liquidity to support economic growth and foster higher asset prices.  The monetary aggregates have expanded at explosive rates.  M1 and M2 increased 51% and 25% respectively in the year ending December 23, 2020.  The Fed’s Balance Sheet which expanded from $4 trillion to $7 trillion has begun to rise further.

Real interest rates (inflation rate less the nominal rate) are negative and are likely to become more so as the monetary authorities maintain a near zero fed funds rate policy.

Negative real rates are associated with a rising economy and equity market.  The yield curve is positively sloping and has steepened lately as long-term rates have moved up.  A positive yield curve foreshadows rising economic activity.  The monetary authorities have made it very clear that they plan to adhere to this rate policy for the foreseeable future to achieve maximum employment and reach their symmetrical 2% target which has been missed for over a decade.  They now employ flexible inflation targeting, wanting to average 2% over time.  Consequently, to achieve this goal requires a higher rate of inflation than 2% for a period of time.  Some board members are comfortable with a 3% rate in order to attain the long-term sustainable goal.  Moreover, some new voting members of the FOMC have a slightly more dovish view than the members rolling off the committee, thus enhancing the accommodation bias.

In recent months, the by-product of the level of interest rates and stimulus programs has been the weak dollar.  However, as we move into earning season, the multinational companies will be getting a tailwind from the weaker dollar.  As a result, some upside surprises may be forthcoming.  Given the inability of analysts to forecast earnings in this difficult period, better-than-expected earnings seem likely to occur similar to last quarter.  The fiscal and monetary environment supports a broadening of markets with many more groups participating and cyclical growth becoming more important.

Much has been made about growth vs. value.  We believe it is not about either, but more about achieving your goal by growing income and asset values.  Disturbing well-established asset positions to play a move to value because of someone’s questionable definition of value (and a valuation gap that cannot be adequately determined) is highly suspect.  We believe maintaining your discipline and focusing upon the emerging opportunities is likely to generate favorable results in the current fiscal and monetary environment.