The stock market continued its pronounced upward march during the 4th quarter, with the benchmark S&P 500 hitting a series of new all-time highs after a brief pre-election pullback. While this seemingly one-way move will not continue indefinitely, vaccine approvals and distribution point toward improved corporate earnings prospects heading into 2021. Analysts have begun reflecting this outcome in published earnings estimates, and additional vaccine approvals in the 1st quarter news cycle could stoke further upgrades. With the S&P 500 closing 11.69% higher for the quarter, current market levels likely price in at least some of this optimistic outlook, but there is tremendous economic potential waiting to be unleashed once health concerns demand fewer limits on mobility and activity. Given the fact financial markets typically look forward six to nine months into the future for direction, the continued rally witnessed in the 4th quarter looks justified.
The final 3rd quarter G.D.P. tally showed economic activity jumped an impressive 33.4% on an annualized basis. The Federal Reserve Bank of Atlanta’s running estimate of current quarter economic growth (“G.D.P. Now”) indicates a roughly 10% rate of expansion, sharply higher than economists project. That pace of growth would mean the U.S. economy shrank only 1% during 2020 despite tremendous hardships. A realistic 4.5% G.D.P. growth target in the 1st quarter would see the economy return to the same level of activity seen at the end of 2019, prior to Covid’s onset. While rising case counts may lead to broader activity restrictions that dampen near-term growth, more widespread inoculations offer the promise of increasingly normalized activity levels as the calendar moves further into 2021. “Normal” may look different in some respects moving forward, but economists anticipate eventual removal of stay-at-home and social distancing restrictions will mean that more sectors of the economy see improving business conditions and employment levels by mid-year.
Stock market returns exhibited a distinctly cyclical flavor during the 4th quarter with Energy, Financial and Industrial shares leading the way. Though Energy has likely seen the worst from a cyclical standpoint, increased focus on and improved economics for renewable and sustainable energy sources represent longer-term headwinds for traditional energy companies. Financials also lagged for the year, but their balance sheets proved quite resilient during 2020’s challenging economic conditions. Modestly higher longer-term interest rates accompanying stronger economic growth could prove beneficial for earnings moving forward. Investors expect demand to improve in the Industrial sector as delayed projects and purchases come back on line. There is anticipation Congress may move on large-scale infrastructure legislation that would boost Industrials. Communications Services stocks continue to benefit from increased streaming video traffic as consumers shift how they view content. Information Technology also topped the S&P 500, as secular trends continue to emphasize digital transformation along several fronts. Those trends have only accelerated in 2020. Consumer sectors lagged after leading much of the year. Real Estate continued to lag as investors consider what the post-Covid future looks like for office space, malls and hotels.
Long Term View
The S&P 500 finished the year up 16.26%, a strong performance by historical standards. Obviously the “final score” doesn’t quite capture the journey to that outcome. Plunging economic growth and company earnings do not sound like a recipe for strong stock market performance, but it’s important to remember some key facts. First, the stock market is not the economy, and vice versa. Additionally, the stock market is a forward-looking mechanism, peering past good or bad current news to what’s on the horizon. Finally, the recession witnessed this year resulted from a specific event rather than financial or economic excesses accumulated over the span of years that typically take years to work off. There’s reason for optimism heading into 2021 as the world can hopefully leave this painful stretch behind and return to more normalcy. No doubt future years will reveal their own surprises, but we believe investors will continue to benefit from professional advice in building a durable long-term portfolio that can weather surprises.