Adviser Outlook, First Quarter 2021 - Adviser Investments

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Adviser Investments Market Outlook

Adviser Outlook, First Quarter 2021

Quick Takes

  • Stocks rallied worldwide in the final months of a challenging 2020 and investors barely missed a beat following the conclusion of the highly contested presidential election, with U.S. stocks returning 11.8% between Election Day and year-end
  • Risks to global recovery remain: U.S. trade relations with China are strained, European economies are struggling and the COVID-19 toll is rising worldwide
  • Signs of economic healing and accelerating vaccine rollouts give us a measure of reasoned optimism about 2021

Despite ringing in a socially distanced new year at home, 2021 should mark the end of the COVID-19 pandemic and the probable beginning of a return to some form of normalcy worldwide. But our troubles aren’t over yet. A sobering reminder, the storming of the Capitol, shows that the country has yet to find a cure for its political divisions. Meantime, trade relations with China are strained, Europe’s economies are in relative shambles and coronavirus infection rates and mutations are just a few of the known hurdles we face out of 2021’s starting gate.

In the months preceding the new year, COVID-19 vaccines and investor relief following the long and bitter presidential election campaign helped propel stocks steadily upward, not only erasing the dramatic losses from the spring’s coronavirus crash but establishing new highs for most of the major market indexes.

Lessons learned from past elections were reinforced by the current one: Transfers of power in the U.S. have not proven to be a sell signal for stocks. As often as pundits assert “the markets” crave stability, continuity and “business-friendly” candidates, the S&P 500 index returned 11.8% from Election Day through year-end. It also closed at a new high on the day of (and the day after) the assault on the Capitol.

We remain wary, though, that traders’ enthusiasm is potentially setting us up for a market correction if there’s a setback in the vaccination rollout, prolonged civil unrest or extended pandemic shutdowns.

While investors have looked past tumultuous politics and civil disorder so far, the pandemic has taken its toll on several levels. More than 400,000 Americans (2 million people worldwide) have died from the coronavirus and the totals are rising. Containment measures and shutdowns have left us with 9.8 million fewer jobs in the U.S. than we had back in February 2020; meanwhile, our economy is 3.5% smaller than it was at the start of last year (based on third-quarter numbers). The compromise round of stimulus passed by the lame-duck Congress should help, but we think much more is needed.

The results of the Senate runoff in Georgia are positive for the economy. A consolidated government creates the ability to provide stimulus and initiate job-creating infrastructure spending on a massive scale.

As we outline below, there are also numerous signs of healing in our economy that should create new opportunities for long-term investors like us. It may not be an easy or comfortable period of transition, but we are on the path to recovery in several senses of the word.

Let’s take a quick look back at what happened in the markets to end 2020 before looking ahead.

Fourth Quarter Review

  • Foreign stocks set the pace in Q4, with the MSCI Emerging Markets index returning 19.7% and the MSCI EAFE index of developed markets up 16.0%
  • U.S. stocks had a strong finish: The MSCI U.S. Broad Market index returned 14.8% in Q4 and 21.0% in 2020
  • Every U.S. stock sector had a positive return in the fourth quarter; energy (up 29.5%) and financials (25.3%) led the way
  • The U.S. bond market followed up its 8.7% return in 2019 with a 7.5% gain in 2020, eking out a 0.7% advance in Q4

U.S. stocks posted double-digit total returns in the fourth quarter. While it did not match its pace from Q2 (when it was up 20.5%), the S&P 500’s 12.1% gain was the 13th-best calendar quarter (out of 120) for the benchmark since 1990. Boosted by small-company stocks, which outpaced their larger siblings, the MSCI U.S. Broad Market index returned 14.8% over the last three months of 2020 and 21.0% for the year. The Dow Jones Industrial Average gained 10.7% in Q4 and 9.7% for the year.

Momentum shifted in favor of foreign stock markets in the fourth quarter, where gains were aided by a weak U.S. dollar. The MSCI Emerging Markets index returned 19.7% over the final months of 2020 and the MSCI EAFE index of developed markets gained 16.0%, both outpacing the U.S. stock market over the period. For the year, emerging market stocks’ 18.3% return nearly matched the S&P 500’s 18.4% gain.

Stocks Advance Through Year-End

wdt_ID Index Q4 2020
1 MSCI Emerging Markets 19.7 18.3
2 MSCI EAFE 16.0 7.8
3 MSCI U.S. Broad Market 14.8 21.0
4 S&P 500 12.1 18.0
5 Dow Jones Industrial Average 10.7 9.7
6 Bloomberg Barclays U.S. Aggregate Bond Index 0.7 7.5
Note: Ranked by Q4 returns. Performance numbers are total returns, reflecting reinvested dividends through 12/31/20. Source: Morningstar.

All 11 broad sectors of the U.S. stock market generated positive returns in the fourth quarter but there was a notable gap between the leaders and the laggards. “Value” stocks outperformed in the quarter, led by the energy sector (29.5% return) and financials (25.3%). Still, they were the worst performers overall in 2020, losing 33.2% and 2.1%, respectively.

The consumer discretionary and technology sectors both returned more than 45% in 2020, and while their respective 14.9% and 13.8% returns were far from middling, relatively speaking, they were middle-of-the-pack performers in Q4.

Source: Morningstar.

Despite rising interest rates (and hence, falling bond prices) in the fourth quarter, the U.S. bond market still delivered a return of 7.5% in 2020 to follow up its 8.7% gain in 2019. The yield on the benchmark 10-year Treasury bond fell to an all-time-closing low of 0.52% over the summer, before almost doubling to 0.93% by the end of the year.

Our Outlook

  • The prospects for fiscal and monetary stimulus bode well for the health of the economy in 2021
  • Bond investors should set lower expectations for returns, but not discount the risk-mitigating characteristics of fixed-income investments in a diversified portfolio
  • Pandemic restrictions will continue to influence economic outcomes; once enough people are vaccinated, we could see a surge of pent-up demand driving sales, profits and job growth in suppressed sectors (travel, leisure, restaurants, etc.)

Based on fundamentals, like corporate earnings and interest rates, and the rollout of COVID-19 vaccines, we are reasonably optimistic about 2021.

Earnings growth for S&P 500 companies has steadily improved in the wake of steep declines last spring. If the trend continues, it could create a tailwind for stocks in 2021. Still, we expect some reversals of fortune as the pandemic eases: Stay-at-home companies that thrived, like Zoom and Peloton, might not sustain their rapid growth. Instead, we may see some rotation into sectors that did not fare as well amid the restrictions. Mask mandates and social distancing are not going away, but if enough people are vaccinated by the summer, depressed demand for travel and entertainment could see a massive reversal.

Despite job losses, household balance sheets have gotten stronger and savings far outstripped spending over the last 10 months as enhanced unemployment benefits and stimulus checks found their way into savings accounts. With restaurants restricted and travel way down, there were fewer places to spend money. Further rounds of fiscal stimulus will likely address unemployment and fund job-creating infrastructure—all providing additional fuel for consumer spending.

With cash on hand and more time spent in front of screens, novice investors continue to dabble and speculate. New accounts and trading volume on platforms like Robinhood and Webull swelled, potentially increasing market volatility in 2021. Bitcoin shot up, nearly trebling in price after the election to over $40,000 a coin. Special-purpose acquisition companies (SPACs), which are often speculative, made up almost 60% of all initial public offerings in 2020 (read more on them here). We believe this increased risk appetite may be a sign that certain stocks and portions of the stock market are overpriced.

Foreign stocks appear relatively less expensive today compared to U.S. stocks, even after their strong finish to the year. U.S. investors’ overseas holdings are poised to benefit from the weak dollar and favorable exchange rates. We think this is an area of opportunity for skilled active managers and will continue to assess not only the role but the types of and allocation to foreign stock funds in client portfolios.

Monetary stimulus was a force behind the stock markets’ gains. While the Federal Reserve has signaled it has no intention of raising interest rates anytime soon, that could change if we see a faster pace of expansion or inflation—which would have a negative impact on bond prices and a positive one on yields. For now, we believe investors should set fairly low expectations for bond returns. Yields, which are low today, are a good predictor of returns over the ensuing five to 10 years. (You can read our “bond guy” Chris Keith’s 2021 fixed-income outlook here.)

That said, bonds are a valuable tool for managing the amount of risk in a portfolio. Again, we believe there is the potential to outperform the overall bond market by hitching our portfolio wagons to active managers with the flexibility to go where they believe they can earn the greatest bang for our bucks.

We’re looking forward to what this quarter will bring. A turn towards normal, whether political, societal, epidemiological or economic, will be welcomed— but normalcy as we knew it may be a year or more away. The vaccine needs time to work to protect your health and we will remain vigilant in protecting our clients’ wealth. Our investment discipline leads us to look for opportunities for upside while we also emphasize prudent restraint in how we manage for known risks. As always, Adviser Investments is here to assist in every way we can to help our clients secure their financial future.

Personal Finance Focus

Post-Pandemic Tax Planning

An end to the pandemic is coming into view—but its impact has both near-term and longer-term ramifications. Here are a few things to keep in mind as you review your financial picture and engage in tax planning for the new year.

  • RMDs are back. The first COVID-19 relief package passed by Congress last spring suspended required minimum distributions (RMDs). Having the flexibility to skip withdrawals in 2020 was a boon for many retirees, but Congress allowed the provision to expire in December, meaning you’ll need to plan to take withdrawals from tax-advantaged retirement accounts again this year.
  • Remote work can offer tax advantages. Whether you considered it a perk or purgatory, the abrupt shift to remote work might mean you upgraded your home office last year. If so, you may have the opportunity to itemize new recurring costs like upgraded internet service or a second phone line. Figuring out how much you’re entitled to claim can be complicated, so we recommend talking to a wealth management professional about your specific situation.
  • Your state income tax may look different. If you spent the bulk of 2020 in a different state than you expected, your residency status for tax purposes may be affected. Financial planners are already warning that we could see a surge in residency audits from states with high income taxes like New York, California, Connecticut and Massachusetts. The Supreme Court may soon provide additional clarity on the topic.

We’re keeping a sharp eye on these issues for you. In the meantime, please don’t hesitate to contact Adviser Investments for personalized help.

Company News

Colette Phillips

Adviser recently launched its I.D.E.A. (Inclusion, Diversity and Equity at Adviser) Speaker Series with Colette Phillips, communications consultant and one of Boston magazine’s “100 Most Influential Bostonians.” She led a lively discussion about the ROI (Return on Investment) of diversity and inclusion. As Ms. Phillips noted, “Diversity is a strength. It makes sense in a portfolio and it makes sense in a group of people.” We couldn’t have said it better ourselves.

This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

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