Windsor Perspectives: Q1 2021
As a most unusual year finally ended, we set our sights in 2021 and beyond. The last quarter of 2020 was quite a sleigh ride with investment returns rivaling anything investors have experienced during the same time period in the last 40 years. The last two months of any year are typically strong for the stock market, with an average gain of 4% over that period between 1975 to 2019. This year markets rose over 12% during the same timeframe.
These strong returns stood in dramatic contrast to an extremely worrisome year for individuals personally, as well as for many sectors of the economy. As feared during the onsite of Covid-19, the advancing winter brought a spike in Covid-19 cases and in the tragic death toll. We again express our deepest sympathies to everyone directly impacted by loss during the pandemic.
Despite the grim health environment, stock markets across the world began to anticipate an economic recovery based on the potential for Covid-19 vaccines. The stock markets cheered when these vaccines became reality and began to rollout under FDA Emergency Use Authorization to front line health care workers and top public officials. And while the economy healed over the summer and fall months with falling unemployment falling and recovering corporate profits, that process temporarily paused and even deteriorated as Covid-19 cases once again began to rise. Fortunately, the approval of additional fiscal stimulus provides a bridge to a 2021 economic recovery, allowing global stock to gold their gains.
Overall, despite the volatility, equity markets returned a very good year with the S&P 500 advancing 18.4%. The distribution of US stock returns, which were narrow and led by well-known technology companies earlier in the year, broadened out in the fourth quarter.
Percent of S&P 500 Members Above Their 200-day Moving Average
Source: JP Morgan
This somewhat narrowed the gap between value and growth styles of investing as share prices of cyclical companies in sectors like industrials and materials participated in the rally. Likewise, small cap stocks rebounded from earlier year losses and became beneficiaries of the expected early stage of an economic recovery. While this optimism is grounded in the likelihood of continued improvements next year, signs of excessive bullishness are beginning to register and need to be monitored.
Outside the US, much of the Eurozone began to fall into a double dip recession, while the Asian economies, led by China, have experienced a stronger growth rebound. As such, the MSCI All Country World Index Ex-US, which measures developed international and emerging market equities, increased 11.1%. The relatively lower valuations outside the US and rebound in economic activity helped international stocks erase their losses from earlier in the year. To close the year, Britain finalized the Brexit agreement with the Eurozone, a process that stretched on for an unexpected four-year time period, but now provides increased certainty on how trade will be conducted.
In the bond market, interest rates rose from an all-time low, as the 10-year Treasury bond yield rose from 0.66% in to 0.93% to end the year. While the overall level of interest rates remains low compared to history, an increase in rates is another sign of confidence in the economy and indicates that we are in the early phases of a recovery.
U.S. 10 Year Treasury Bond Yield (%)
Mortgage rates continue to hover near all-time lows, which has supported brisk home sales and pushed house prices higher. Combined with limited housing inventory across many markets, housing has been one of the unexpected beneficiaries in an uneven and difficult economic environment.
Looking ahead, traditional cyclical companies, many of which are represented in the value style of investing, may finally have their day in the sun after many years of being overshadowed by the largest growth stocks.
The Russell 1000 Growth Index vs The Russell 1000 Value Index
Source: Bloomberg and Fundstrat
In addition, the largest growth stocks make up a disproportionally large part of the overall US stock market as represented by the S&P 500. As the breadth of the market expands, represented by the number of stocks participating in the market rally, this extreme concentration should continue to decline and provide broader overall market performance.
The Top 5 and Top 10 Firms Make UP a Historical Amount of the Market Cap of the S&P 500
Source: JP Morgan, FactSet and Standard & Poors
On balance, we see improving opportunities for the stock market in the areas of smaller capitalization companies, value oriented cyclical and well as international equities.
These opportunities are balanced against low bond yields which will both reduce the income generated from the bond allocation of a portfolio and create a headwind if rates continue to rise in response to an improving economy.
Risks to a potential economic recovery remain as continued Covid-19 challenges lead to fears of a double dip recession, similar to what Europe is currently experiencing. In addition, valuations across markets are near historic records, which can mute the level of future stock returns. High valuations can stay lofty and the vaccine roll-out should lessen the impact of Covid-19.
This past year underscores the importance of adhering to long-term allocation targets that are aligned with your unique objectives and willingness to assume risk. We plan to continue to actively rebalance to manage risk and seek opportunity within a long-term, goals-based investment framework.
As we look forward to navigating the risks and opportunities in the year ahead, we are grateful for your continued trust and confidence in our team.