As the year winds down, it goes without saying that 2020 has been a year like no other. A microscopic virus triggered a global pandemic, which led to both a severe recession – followed by a recovery – and a stock market collapse – followed by a stunning recovery.
It also contributed to the environment that led to social unrest with no apparent recovery. All this fed into a bitter presidential election, leading to a new President-Elect, but with little evidence of recovery in relations between the two dominant political parties in the country.
All of this historic turmoil created tremendous anxiety and volatility in the financial markets. But in looking at overall investment returns from the beginning of the year until now, it is surprising that 2020 is a year very much like many others, albeit with a vastly wider dispersion of returns across various market sectors.
Although the S&P 500® Index is up approximately 10% year to date, only five mega cap technology stocks, which collectively are up nearly 50%, have been the fuel behind the broader market’s advance. Stripping out these five stocks, the other 495 stocks in the S&P 500 Index are up collectively a modest 4%. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 large capitalization stocks.)
Many economically sensitive stocks, especially in Energy and Finance, have suffered significant declines. International markets have badly trailed the U.S. market, with basically flat returns. Meanwhile the bond market has generated solid returns of 5-7% year to date, but has been driven predominantly by price gains, not coupon income.
Most investors have, or should have, well diversified portfolios. Such portfolios include domestic and international stocks, including growth, value, large-cap, and small-cap allocations. They also have some cash, high quality bonds and lower quality bonds to generate income and provide “ballast” to a portfolio.
Whether you were invested in a conservative multi-asset portfolio or an aggressive multi-asset portfolio, chances are your returns would have been remarkably similar. Using median return data from Lipper Analytical Services, a moderately conservative multi-asset portfolio (featuring a high bond allocation) is up approximately 5% year to date, while an aggressive multi-asset portfolio (featuring a high stock allocation) is up approximately 6%. This is quite a narrow performance differential given the very different levels of risk. Still, these overall portfolio returns are well ahead of inflation and are also in line with long term expected returns.
Going forward, it is very unlikely that there will be such similar returns for portfolios with very different asset allocations and risk profiles. The winds of change are beginning to blow in the political, economic and medical research landscapes. These changing winds are also affecting the financial markets and prospective relative returns across asset classes going forward.
How politics and a new vaccine may shape the markets
Politically, the changing winds have led to a new President-Elect. Although Joe Biden won a somewhat narrow victory in the electoral college, the widely expected “blue wave” that would have captured control of the U.S. Senate has not yet materialized.
The equity market has reacted favorably to a presumed split in political power, given that such a split would reduce the chances of a dramatic shift in tax policy, while increasing the chances of near-term fiscal stimulus. These political winds will remain unpredictable in the few months ahead, given legal challenges to the election results, potential actions that a lame duck president pursues, and reaction to new cabinet candidates and policy ideas that President-Elect Joe Biden will initiate.
The biggest, and most soothing, changing wind “gust” is coming from the extremely positive news regarding the development of vaccines to combat COVID-19.
Success on the vaccine front has always been the key to stabilizing and buttressing the durability of the economy and markets. If successfully developed, rapidly produced in scale, efficiently distributed, and widely embraced by the public, a COVID-19 vaccine is a game changer for the country and for the economy.
Recent news on this front is very encouraging, but it comes at a time when COVID-19 infection rates are stressing the healthcare system and leading to rapidly rising death rates. This changing wind will ultimately be the catalyst to lifting the cyclical sectors of the economy and markets that have so significantly lagged those sectors that have sailed through, if not prospered, during the pandemic.
The Federal Reserve is also expected to continue a policy designed to help buoy the economy while the country recovers from the economic fall-out of the pandemic.
Bond and stock market movements
In the bond market, interest rates have begun to rise, and the rally in the high-quality bond market seems to be over. This is happening even as large inflows into bond funds continues. However, with bond yields so low, high quality fixed income investments – especially treasury bonds – will not provide the income and diversification benefits to a portfolio as they have previously.
In the stock market, there are preliminary signs of investors rotating from the long-time winners of large-cap growth stocks, especially technology, and into more cyclically sensitive areas such as value and small-cap stocks.
The relative performance and valuation gaps are now so wide that beginning a move to the small-cap, mid-cap and value sectors of the market seems warranted. The key for individual investors is to stay engaged and committed to a well-thought-out, long-term approach to your investment portfolio as the U.S. prepares to inaugurate a new administration.