2020 was a year of hardship for many people around the world. Much of this difficulty was well broadcast by the media – social and otherwise – so we thought it best to focus this piece on 2021 and what may lie ahead in terms of the effectiveness of the vaccines and what that means for financial markets.
The vaccines currently available show great promise in mitigating and eventually wiping out the COVID-19 virus, which we know comes as a great relief to citizens of the world. The current challenge is distributing the vaccine as fast and effectively as possible to chase down the record amount of new cases. While this is a race that we think will undoubtedly be won, we know that it won’t be as easy as many think. The sheer number of people around the planet, if not just the US, is staggering. While we look forward to the time when we can once again “dance in the streets” it’s probably best to take some time to polish those shoes, since they won’t be needed quite yet.
The challenge, unevenness and potential roadblocks of distributing the vaccine over the next few quarters of 2021 may cause unexpected volatility for financial markets. While we expect this volatility to be nothing like 2020, we do think investors should be prepared for the unexpected. The good thing – at least at this point – about financial markets is that they serve as a discount mechanism for future good news about the economy and corporate profits – hence the stock market’s continued strength as it “prices in” a better economy ahead. We think the stock market’s upward direction is right – again! In fact, after a very deep global economic recession, we would argue that we are on the precipice of a new – maybe very different – business cycle and bull market. The likes of which could last many years. If the vaccines can fully take hold in 2021 we could easily see an economic boom similar to what is usually only experienced in post-war eras. A period that combines rising consumer confidence, optimism, stronger economies and higher stocks prices – one we won’t want to miss!
What’s that you say? “The market is overpriced at this point?” We would agree that parts of today’s stock market are indeed overpriced, but the vast amount of domestic and foreign stocks are trading at the same levels as at the beginning of 2018 – that’s three years ago. In fact, market indexes are just slightly higher today than they were three years ago and if you combine that with future, better-than-expected earnings, most stocks are darn cheap by historic standards. When we look at sectors of the stock market we can’t help but see great opportunities in sectors that would rebound as the economy opens up. These include consumer discretionary, financials, energy, industrials, technology and materials. The danger in today’s market lies in some of the significantly overpriced IPOs and other speculative stocks with literally zero profits – but this doesn’t count for much of the world’s market capitalization so it should not be a concern for the rest of us.
In terms of the bond market we can see a day of reckoning for bond prices particularly on the long end of maturities and for bond fund investors in general. Shorter term, high quality bonds such as the ones you own will hold up just fine. New business cycles and bull markets often coincide with rising interest rates and we don’t think this period will be any exception. Though the Federal Reserve and foreign central banks may want to keep interest rates low, market forces will likely not comply and investors should prepare by reducing long maturities and bond funds that are vulnerable to higher rates. Though we haven’t seen any material inflation since the Rolling Stones recorded “Start Me Up” in 1981, it’s possible that this new business cycle may ignite inflation and the higher prices that come with it. This is inherently bad for longer term bond prices. What’s the best way to combat inflation? Stocks – particularly those of companies that can raise prices.
As you can surmise we are bullish. Many stars seem to be aligning for better days ahead for the world and financial markets. However, we realize that we are operating in a world of the “known” and “unknowable.” In the event that our optimism is misplaced, we are prepared to manage significant downside risk in your portfolio by being flexible with your asset allocation, sector management and the use of carefully placed stop loss orders. This combination of what we call Active Risk Management has served us well through many bear markets.
We hope you find this update helpful and all of us on the team want to thank you for your continued vote of confidence and wish you a very happy and healthy 2021!
If you have experienced any significant change in your financial situation or have questions about your portfolio please let us know.
Your Team at Main Street Research