The 2020 fourth quarter COVID spike is pressuring near-term economic growth, which will likely spill over into early 2021
Targeted fiscal stimulus will help hard-hit sectors
Monetary policy should remain accommodative, preventing interest rates from reaching a level where they would constrict economic growth
Widespread access and adoption of COVID-19 vaccines should bring an end to the pandemic, ushering in a global economic recovery
After the short-term spike in growth in 2021, we will likely revert to the slow-growth environment of the last few years
Inflation may rise off a low base, but we do not expect a sustained increase
Normalcy may still be a way off, but each day we inch closer. Flipping the calendar to a new year brings wishes for a fresh start, one without our current woes. Unfortunately, it does not work that way. 2021 will not magically vanquish the global pandemic of 2020 – and all the troubles that came with it. In fact, recent weeks have brought about a new surge in COVID-19 cases, and this will almost certainly challenge the pace of the recovery into early 2021. However, help is on the way. Multiple highly effective vaccines are already being distributed, a definite positive light at the end of the tunnel. We expect that as vaccines become more widely distributed, we will begin to emerge from the once-in-a-lifetime challenges wrought by the pandemic. As we breakdown what this means for the economy and markets, we are encouraged by the trajectory of change that is on the horizon.
2020 was an unprecedented year for the labor market. As the global economy came to a halt in April, so too went millions of paychecks. Never in our history have so many jobs disappeared so quickly. With millions of American families on the verge of collapse, the federal government provided a short-term lifeline to bridge the gap until the economy could reopen. Without this government support, the U.S. would have entered a depression.
As the year progressed and businesses reopened, employees went back to work. By the end of 2020, slightly over half of the jobs lost have been recovered (Figure 1). However, this still leaves more room for improvement. As we look forward to the year ahead, we expect a further recovery of lost jobs in the U.S.
The hardest-hit employment sectors are those most directly impacted by the pandemic – hospitality and leisure, travel, and entertainment (Figure 2). These sectors have been slow to recover but we expect improvements over the coming year as COVID-19 vaccines are distributed throughout the world.
However, while the labor environment improves, we expect some job losses to be permanent. A vast majority of the employment disruption is temporary, but structural shifts are occurring within the U.S. economy that we believe will change the labor landscape. The long-term impacts of these structural shifts mean some jobs will no longer be needed, while other new jobs are being created daily. These structural changes cause some short-term pain but should be a net positive for the U.S. economy long-term.
The U.S. consumer continues to impress. In many ways strong consumption has allowed our domestic economy to survive even amid a global pandemic. As the largest part of the U.S. economy, consumers did not miss a beat in 2020 and we expect pent-up demand to drive further improvements in 2021.
Consumer confidence took a hit as the pandemic spread, but has since recovered remarkably. The resilience of U.S. consumers is quite impressive. Much of this is due to the quickness of federal government support for Americans who lost jobs or were forced to take pay cuts. Stimulus checks boosted savings rates at the same time many Americans were finding it difficult to spend money. We expect further government stimulus to add to this impact in 2021.
With this being said, consumer behavior changed in 2020. Spending on services declined significantly from pre-pandemic levels and has yet to recover (Figure 3). To the contrary, spending on goods recovered very quickly and moved to new highs in the second half of 2020 (Figure 4). This shift is logical as many service-oriented businesses require direct in-person contact. Looking forward we expect this shift to revert to more normal levels as inoculations spread throughout the world. While we do not expect every service-oriented business to return to pre-pandemic levels overnight, we do expect the vaccine will provide a base for services to grow.
The COVID-19 pandemic provided a new lens for people to view their lives. Personally, families are re-inventing what is important to them. Professionally, businesses are evaluating the best way to provide goods and services to customers at the same time they are integrating employees’ new work preferences. Together this provides a backdrop for some of the most influential changes in American business history.
At the risk of sounding trite, we expect that the way American businesses operate could be altered forever. The long-term transition to new technology, flexible work schedules, and work-from-home policies accelerated quickly in 2020. We believe the pandemic has fueled a desire for businesses to re-evaluate their operating structures.
Importantly, this means businesses may find even more efficient ways to operate. These new operating procedures will take some upfront investment but could feed productivity growth for many years. We believe the pandemic may be a tipping point for long-term innovation.
The pandemic has also fueled a resurging real estate market. Families have re-imagined their home life and their housing needs. The great migration into the cities is now reversing. Families are looking for lower-cost suburbs with more space. With an increasing acceptance for remote work, many workers are moving their families to low-tax states like Texas and Florida from areas with heavy tax burdens, like New York and California.
This migration is fueling the new construction market. Builders are finding it difficult to keep up, leading to rising prices. At the same time, input costs are on the rise. We expect demand for new homes to outstrip new supply as the urban exodus continues.
As the world continues to recover from the global pandemic there are still many problems to address. However, the worst appears to be in the past. This is important because the trajectory of change moving forward drives markets.
We believe the U.S. economy will transition from “bad and improving” to “good and improving” as COVID-19 vaccines are distributed throughout the country (Figure 5). This return to normalcy will help revive some parts of the economy which have been hit the hardest – sectors that we expect to struggle until the pandemic is over.
Not all countries will benefit as quickly from the new vaccines. The logistical issues associated with transporting and storing the currently approved vaccines present a challenge for developing countries. However, additional vaccines in development will likely ease these infrastructure challenges and allow developing countries to improve as well. At the same time, some developing countries have had prior success connecting monetary payments to inoculations. A well-designed approach can allow developing countries to gain widespread adherence, but the process may take longer.
As the economy transitions back to normalcy, we expect economic growth to run above trend. However, following the short-term spike in growth we believe the economy will revert to the slow-growth environment of the last few years.
Similar to our expectation of an improving U.S. economy, we expect corporate earnings to rebound in 2021 from temporarily depressed levels (Figure 6). Rising earnings will relieve some pressure from stretched equity market valuations. However, with interest rates at rock bottom levels, along with an improving economy, we expect earnings multiples to remain elevated.
Small-cap stocks and value stocks historically outperform coming out of a recession and provide a contrast to the recent outperformance from mega-cap growth stocks (Figure 7). While we expect this to be true during this post-recession period, we believe the opportunity may be shorter-lived. If the economy returns to the slow-growth environment seen in the last cycle, mega-cap growth leadership may return.
We also acknowledge the compositional differences between the U.S. market and other developed markets (Figure 8). In particular, the more cyclical nature of businesses within foreign developed markets may provide a near-term lift as economies across the globe recover.
In addition, recent U.S. dollar weakness has helped boost foreign investments relative to the U.S. (Figure 9) If this trend continues, we anticipate a powerful tailwind to foreign investments.
We believe interest rates will remain low for a long time. The Federal Reserve continues to target rock-bottom short-term rates while acknowledging that they are comfortable allowing inflation to rise above their target in the near-term. However, as the economy improves, we expect long-term rates will creep higher and thereby steepen the interest rate curve.
An improving economy also provides a backdrop for lower-quality bonds to perform well. While interest rate spreads for lower-quality bonds remain low on an absolute basis, relative to rock-bottom interest rates they present an attractive risk-reward relationship under the assumption of an improving economy.
The improving economic backdrop expected in 2021 should provide a positive base for equity investments in the year ahead. While above-average valuation metrics could be a deterrent, we believe equities are attractive relative to other investment opportunities. Small-cap and value stocks historically lead markets in the early part of economic recoveries and present an opportunity for investors. We also acknowledge the increasingly favorable environment for international investments and believe there is less justification for such a significant underweight in the portfolio.
With interest rates expected to stay low, we believe fixed income investments provide a nice buffer to any volatility in equity markets. However, we acknowledge real returns from bonds may be low. The improving economy also provides an attractive opportunity to collect the extra interest available from taking on credit risk above the risk-free rate.
We are adjusting portfolios to align with the improving economic backdrop and to take advantage of the opportunities we have identified. As always, as circumstances change, we will modify our thinking and strategy with the incoming data.
The major troubles of 2020 are transitioning to our rear-view mirror. The process is occurring slowly but should accelerate as COVID-19 vaccines bring an end to the pandemic. While the impacts from COVID-19 will be felt for years to come, we expect a global economic recovery to occur as normalcy returns.
However, 2021 will be a transition year. The end to the pandemic is on the horizon, but it is not here yet. The recent COVID resurgence is pressuring near-term economic growth and further government support of hard-hit sectors is expected before we see the finish line.
As we transition to recovery, the economy remains too frail for significant monetary tightening. Therefore, we expect monetary policy to remain accommodative and interest rates to remain low enough to support economic growth. Inflation will likely rise off a low base as the economy improves, but we do not expect a sustained increase that would lead to concern.
With the global economic recovery taking hold, we believe economic growth will run above average in 2021 but will then likely revert to the slow-growth environment of the last few years. However, a resurgence of corporate investment and innovation could lengthen this spike in growth.
Finally, as we look to the year ahead, we are encouraged by the signs of progress on the pandemic. It remains the world’s number one priority. Widespread vaccinations could finally bring an end to the pandemic and spur a sustainable global economic recovery. Even still, the pandemic has taught us a lot about our lives and the way we do business. We must not forget these lessons as we strive to adapt and improve.
ALLEGIANT PRIVATE ADVISORS INVESTMENT COMMITTEE
Paul B. Cantor, CFA, CFP®, AIF®, Principal, Chief Operating Officer
Cameron Dees, Research Analyst
Will Geisdorf, CMT, Senior Research Analyst
Benjamin W. Jones, CFP®, AIF®, Principal, President, Chief Investment Officer
Luke Nicholas, CFA, CFP®, Principal, Director of Portfolio Management
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Telephone (941) 365-3745
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Advisory Services offered through Allegiant Private Advisors, LLC, a Registered Investment Adviser