Perhaps to a larger extent than any other year in recent history, the events of 2020 will have an enormous impact on the course of 2021. The aftereffects of a global pandemic and a close presidential election are likely to dominate other factors influencing the economy this year. Our expectations have also been shaped by our analysis of the unusual market performance during the 2020 recession and bear market.
2020 was an anomaly for several reasons. First, the downturn happened fast. Unlike the housing bust, there was no reason at all to be cautious ahead of time. There will be no award-winning movies like “The Big Short” about people who predicted the pandemic—the SARS CoV-2 virus was unknown until just a few weeks before the stock market plummeted. Second, the rebound of the stock market to new highs also occurred quickly. Even with the benefit of hindsight, it’s still difficult to believe that stocks would reach record levels while hundreds of thousands lost jobs and lives. In part, the recovery was due to decisive actions by policymakers (and a mix of good science and good luck on the part of vaccine developers). Third, and most important for understanding future implications of the past year, the impact is unbalanced. For those in the restaurant, travel, and entertainment industries, it was a fullfledged depression, with unemployment rates approaching 20%. But for those in white-collar “work-from-home” professions, there have been relatively few job losses and life has been manageable if not completely normal. The speed of the downturn and the actions taken to mitigate it, along with its uneven effects across the economy, lead us to four main investment themes for 2021:
1. Pent-up Demand Will Drive Recovery
Thankfully, the unprecedented speed of vaccine development should put an end to the pandemic by the second half of 2021. Because a significant percentage of high-earners remained employed and able to save during 2020, there is a lot of pent-up demand for travel, restaurants, and other entertainment activities once life returns to normal. The personal savings rate is still about twice normal levels, and those savings should shift to consumer spending as the year goes on. In contrast to the 2008-2009 recession, this downturn was due to a temporary lack of demand rather than excess supply. That spending will flow through to other areas of the economy. For example, simply leaving the house requires more gasoline and auto maintenance than staying at home. Housing may benefit as well. The confluence of aging millennials, low rates, lack of supply, and possibly a post-COVID shift in preferences back to the suburbs from densely packed urban areas could be good for the economy as the year progresses.
2. The Virtual Economy is Here to Stay
We also believe that the COVID pandemic accelerated the secular shift from the physical to the internet economy. It took about 10 years for ecommerce to go from 5 to 10% of retail sales, but online shopping accounted for more than 15% of the total by late 2020. Some of that may reverse temporarily as the economy reopens, but we are not betting on the end of this trend. COVID also forced companies to adopt virtual meetings rather than constant global travel. Corporations account for a significant percentage of travel and entertainment spending, and the cost savings associated with the successful use of Zoom and other similar technologies may be difficult to give up. This dynamic has also required new investments in software and technology infrastructure as business became increasingly virtual and applications moved to the cloud.
3. A Leftward Political Turn Favors Labor
Lessons learned from the financial crisis clearly mitigated the impact of the COVID pandemic. The government provided fiscal stimulus with the CARES Act, which provided $2 trillion in direct payments and other types of financial aid to keep consumer and small businesses out of bankruptcy. The Federal Reserve added monetary stimulus by cutting short-term interest rates back to zero. With the Democrats holding the House, Senate, and the Presidency, spending seems likely to continue. Regulation may also play a larger role over the next two years. Inequality has been a growing problem around the world for several years, and with the effects of COVID furthering the gap, we expect to see the new administration adopt policies that favor labor over capital to some extent.
4. Reflation Will Drive Volatility
For more than a decade, inflation has been very low and the Federal Reserve has been very accommodative. Interest rates fell in 2020 from levels that were already very low. The combination of low rates, higher spending, and rebounding demand could be the catalyst to finally boost inflation again in 2021. Of course, this dynamic is difficult to manage from an investment perspective due to feedback mechanisms between interest rates, the economy, and stock prices. Low rates lead to more economic activity and higher stock prices, which eventually leads to inflation and rising rates, which produce lower stock and bond prices. Thus, an improving economy could produce higher earnings but lower multiples with little to no safety in bonds (bond prices fall as interest rates rise). Already, the ten-year rate has doubled from its 2020 lows. Cyclical stocks and those levered to hard asset values may benefit if this trend continues, and volatility of stocks and bonds could increase as corporate earnings, government actions, and inflation interact.
In summary, 2020 reminded us that the course of the global economy is never completely predictable. While some things may never return to the way they were pre-COVID, we remain optimistic about 2021 as the vaccines are dispersed, and we begin to embrace our “new normal”. As always, the portfolio management team at Fragasso will continue to make investment decisions guided by time-tested principles and your needs and goals.