In 2020, we witnessed a global pandemic, a sudden recession, the rapid development of a vaccine, and a contested U.S. presidential election. Any of these events alone would be enough to cause turmoil, so to say that 2020 was an eventful year for investors would be a massive understatement.
We expect 2021 to be extremely interesting in its own right, hopefully with the headline being that the global vaccine rollout spurs a strong and sustainable economic expansion. Vaccinations, which are expected to be widely available in the U.S. by mid-2021, should nudge the economy back to at least shades of normal life.
But what will “normal” life look like in a post-pandemic world? Will restaurants, ballparks, and classrooms be full? Will corporations require workers to be in offices? Will Americans continue to wear masks? It will be fascinating to see what aspects of pandemic life become ongoing parts of everyday life and how those habits shape the economic recovery.
Summary of last quarter.
The middle two quarters of 2020 saw an astounding V-shaped recession and recovery, with U.S. GDP falling 31.4% in Q2 and rebounding 33.4% in Q3, according to the Bureau of Economic Analysis. This momentum continued into Q4 in terms of improved unemployment, manufacturing activity, and retail demand, but the momentum appeared to be slowing by the end of the year.
Congress agreed to another stimulus package in late December, which should extend momentum for the short term. Market valuations reached elevated levels in anticipation of additional stimulus packages and the release of a vaccine; meanwhile, inflation has remained stubbornly low.
Our commentary.
It is worth noting that the massive amounts of fiscal and monetary stimulus provided by the Federal Reserve and Congress played a large role in spurring the remarkable economic recovery seen in 2020. We won’t consider the economy to be healthy until it can expand on its own without being reliant on stimulus. It is also worth keeping in mind that the economy is still smaller than it was 12 months ago.
Employment is arguably the key to any economic recovery, and current unemployment is 6.7%, according to the Bureau of Labor Statistics. While this is drastically better than the 15% seen in May, it will take considerable time to get back to the normal 4% target. Still, the economic recovery has been dramatic, and it appears that the U.S. economy is in the early stages of recovery. The pace of the recovery will likely depend on the need for future shutdowns and the speed of the vaccine rollout.
Inflation is another key factor to watch closely. The massive amount of stimulus during the pandemic and the growth of the money supply should eventually lead to an increase in inflation. The Federal Reserve has stated that it isn’t considering raising interest rates and will let inflation run past the 2% target rate. This may seem like an appropriate approach given how stubborn inflation has been to materialize so far. But inflation is notoriously difficult to predict and manage.
You’ve heard us say that that the stock market is always looking ahead of the general economy. Currently, investors seem to be looking ahead by about three to six months. This gap and the uncertainty about what will occur during those months explains a large part of the valuation discrepancies in the market today.
As of January 7, we viewed stock markets as being overvalued, but relative to bonds they offer the better risk premium. Still, we expect a normal market correction at some point in 2021 to get the markets back in-line with valuations. That correction may be the first marker of the economy getting back on its own feet, firing the starting gun of the inflation race.
Until next quarter,
-Investment Committee
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