The Disparity Between Growth and Value
2020 was a historic year for many reasons: The worst pandemic since the late 1960s (Hong Kong Flu); the fastest development of a vaccine to combat the Coronavirus; the fastest 30 percent sell-off in history (22 days); and the fastest recovery of a bear market of 20 percent or more in US history (191 trading days).
It also added to the divide between growth and value stocks. Value stocks underperformed again in 2020 as it has for the last 5 years or so. At some point, investors will rotate back to value vs growth. It is difficult to know exactly when. As we look at history, the chart above indicates in the late 90s this occurred to a Beta of over -3 before storming back for the better part of the 2000s. We may need to consider looking at beginning a rotation into value sometime in 2021.
The Returns of The Top 10 Drive The Index
The stock market has been led by a narrow list of names. The earning of the top 10 companies on the exchange represented 28.6% of the return and 23.7% of the earnings of the S&P 500. There needs to be a rotation to more companies if the market is to continue to climb higher.
The Stock Market vs The Economy vs The Jobs in The Pandemic
In this market recovery, it has become apparent there is a difference between the market, the economy and jobs. It is especially obvious when we look at where the earnings are coming from as compared to where the jobs have been lost and where job growth is occurring. 38% of the S&P 500 market capital weight comes from technology which supplies only 2% of the jobs in the economy and 6% of the GDP of the United States. Government spending represents a large part of the GDP share and the jobs, but are not represented in the stock market. As we go into recession these sectors tend to see the most contraction. So, the earnings of the tech sector are what drive the index’s result.
That is why the gradual improvement in the economy does not match the rapid recovery in the stock market indexes. It further stresses it matters greatly what sectors and/or industries from which our portfolio managers select their holdings.
The Rise of Populism
You may have noticed we have been in a period of rising populism. It has brought us Brexit in the UK, Donald Trump in the U.S., perhaps starting with the rise of the Tea Party in 2009. The reason may very well be the wealth gap. The system works well for those at the top and not so well for those at the bottom. This is causing a continued rise of populism on both the left and the right. The current use of monetary stimulus in reaction to the global financial crisis and now the Covid-19 pandemic has exacerbated these tensions. This makes it even more difficult to find common ground on big issues like healthcare, social security, debt and the deficit. Gridlock on big issues will likely remain. It will probably take a shock like higher interest rates before we see changes in these areas. But those challenges lie ahead.
Average Investors Tend to Do the Opposite of What Markets Do
A study of the flows of mutual funds shows that while the markets have experienced 2 years of double-digit gains, investors on the aggregate have been moving money out of stocks and into bonds. Historically, investors pour money into stocks as they peak and sell out as they decline. The chart on the bottom right shows the rising stock market while the flows out of stocks the last few years. This may well mean that stocks have more room for the upside as investors turn from pessimism to optimism as the market continues to climb.
New Administration and New Congress
The goals of the Biden administration are grand.
They plan to reverse the tax cuts of the prior administration and additionally increase capital gains rate to ordinary income on top wage earners to 39.6%. They seek to eliminate stepped-up cost basis at death on appreciated assets. They would also like to tax incomes over $400k, with a 12.4% FICA tax on all earnings above that level.
They are currently contemplating another Covid-19 stimulus package that would send larger checks to individuals and families, enhanced unemployment benefits, additional vaccine distribution money and possibly send money to states to make up for revenue shortfalls.
While the markets may have factored some of the additional stimulus, it is hard to imagine it has digested any tax changes awaiting the work in committees and in Congress on the Biden Administration’s plans.
Monetary Support, Fiscal Stimulus and End of The Pandemic Will Likely Drive The Markets Higher in 2021
The Fed plans to continue quantitative easing into at least 2021, if not beyond and will let inflation run higher than the 2% target of the past. This will provide tremendous liquidity.
"Don't fight the Fed" is back in play.
Additional government stimulus or Covid-19 relief will support consumer demand and hold off a second decline. And the vaccine will allow us to return to a more normal functioning society both here and around the world. I am not sure exactly what the new normal will look like, but it will certainly be better for the economy than the last 10 months.
The challenges remain as to what ultimate tax policy will be that makes its way through Congress. As we get more insight from the final bill, markets may falter if the changes are too dramatic. Expect increased volatility around that issue.
Bryan D Beatty, CFP® AIF®