IF YOU’RE FEELING WHIPLASH from being an investor during 2020, you aren’t alone. In many respects, the past year felt like it lasted a decade – and financial markets and the economy swung at an accelerated pace to match with several years’ worth of activity condensed into one. It felt like we were witnessing a full market cycle at 2x speed. In fact, by some measures that would be an understatement.
On February 19, the S&P 500 notched a new all-time high as 3,386 Covid-19 cases were rapidly accelerating in China, but market participants were optimistic toward containment of the spread, given that there were only 15 recorded cases in the United States. Within just three weeks, on March 10, the World Health Organization declared the coronavirus crisis a global pandemic, and a cascade of event cancellations and lockdown measures across the nation ensued. One day later, the S&P 500 entered into bear market territory, down over 20% from its peak, just 16 market days after posting its all-time high.
It marked the fastest move into a bear market on record. The whiplash continued, as the equity market collapse in the U.S. would only last another seven market days from that point, with the S&P 500 bottoming on March 23 with a loss of 34% from its high. Meanwhile, the severity of the economic decline and the human health toll in the U.S. was just starting to materialize as markets bottomed.
In April, the sweeping layoffs and furloughs wrought by a shock to supply chains and consumer demand in the wake of lockdowns resulted in an increase in unemployment of over 17 million compared to February, reversing a decade of job gains. The total number of unemployed citizens hit 23.1 million, and the unemployment rate reached 14.7%, well past the peak of 10.0% in October of 2009 during the global financial crisis.
U.S. economic output plummeted in the second quarter with GDP growth declining 33.2% on an annualized basis, but the green shoots of the economic recovery were already sprouting by early May. Despite the tremendous depth and speed of the economic shock in the coronavirus recession, the recovery has occurred at an equally blistering pace, though economic output remains below pre-crisis levels. Through October, more than 12 million U.S. payrolls were added back to the economy, meaning that in just six months the economy recovered the same number of jobs that were added back over the course of about five years in the wake of the Great Recession.
The key to such a recovery was preventing delayed consumer demand from becoming demand destroyed, thereby preventing temporary job losses from becoming permanent. Given that, the most important factor in laying the foundation for the economic and market recovery was the speed with which central banks and governments around the world intervened with stimulus at a scale far greater than used in any past crisis.
In the U.S., the Federal Reserve quickly slashed short-term rates down to zero and announced on March 23 plans to purchase bonds and backstop credit markets to ease their liquidity that seized up in March and threatened to turn a recession into a more severe and drawn-out financial crisis. Soon after, confidence in the recovery gained another boost as the U.S. government provided direct fiscal aid through the CARES Act to bridge the gap in lost income as businesses were forced to close and payrolls were slashed. All told, the U.S. government alone has unleashed $2.4 trillion in spending to date to combat the pandemic and its economic toll, with more likely yet to come.
Of course, the pandemic wasn’t the only cause of market anxiety in 2020 as the nation grappled with social unrest, trade tensions and a contentious presidential and congressional election cycle. Although many market participants feared a market unraveling amid the election uncertainty, financial markets continued to demonstrate resilience and climbed to new highs in November as Joe Biden was confirmed as president-elect, with investor sentiment aided by positive vaccine developments.
As the ground dropped out from beneath many industries and workers in this pandemic, stimulus has provided a bridge to the other side of the crisis and promising vaccine developments have brought the other side within sight. We are not out of the woods yet, as many companies are not back to business as usual and the effects of the late fiscal support from Congress are not yet known. However, this year has once again demonstrated the resilience and adaptability of humankind in the face of crisis. Financial markets have reflected this resilience as you can see in the chart on page 11 showing how most asset classes have rebounded strongly off of first quarter lows.
When it comes to takeaways for investment strategy from such a wild ride of a year, 2020 demonstrated the importance not only for staying the course with a long-term perspective and avoiding investment decisions driven by emotion in times of turbulence, but also for being adaptable and forward-looking to account for structural shifts in our ways of life that are often born from periods of crisis. At First Merchants Private Wealth Advisors, we have long held a focus on investing in companies and institutions that demonstrate an ability to be self-sustaining with manageable levels of debt and that maintain competitive advantages that limit the prospects of disruption over the long term.
This focus is especially crucial in times of economic duress. However, while we maintain our core investment philosophy, we will also respond and adapt to the new opportunities and challenges facing our clients in the years ahead, whether that is the impact of changing consumer preferences and business habits across industries, new monetary policies in an era of ultra-low interest rates or changing political landscapes.
Key Themes
AN UNEVEN RECOVERY WITH LONG-TERM IMPLICATIONS
Although U.S. retail sales have returned to pre-crisis levels, the composition of those retail sales in 2020 has been much different from sales in prior years, as shown in the chart at right, indicating an uneven recovery under the surface. E-commerce, home improvement retail and grocery stores have been among the winners in capturing consumer wallet share, subsidized by cuts to spending at restaurants, apparel stores and gas stations.
Equity markets have reflected the uneven nature of the recovery, as stocks leveraged to the “work-from-home” theme – many of them growth-oriented technology stocks – outperformed cyclical, economically sensitive stocks for most of the year. Certainly some of the pandemic trends and ways of life will prove transitory, at least in part.
People will one day return in greater capacity to restaurants, international travel, sporting events and theme parks, though those spaces may look different. However, certain efficiencies born from this crisis will remain. The adoption of broad, secular trends that had been gaining momentum coming into this year was expedited in many cases as individual consumers and businesses alike were forced to consider alternatives to their traditional day-to-day habits.
For consumers, that may mean more lasting adoption of e-commerce, food and grocery delivery, streaming, and the like. For businesses, many firms may look to rationalize spending on their physical office footprint and business travel and increase spending on cloud services and enhancing their digital presence. Each of these changing habits not only has direct implications to the companies involved in those industries but also generates ripple effects to their suppliers and other stakeholders as well.
“Acceleration” is not only a fitting theme to describe the path of markets and the economy in 2020, but it is also an apt descriptor for the shifts in consumer and business behavior around the world that will have lasting imprints on our society and economy well beyond this year.
THE BIG GET BIGGER
Another trend in motion that gathered greater steam in 2020 was the rising influence of large technology companies. Within U.S. equity markets, technology heavyweights outpaced the pack in 2020 due to exposure to at-home trends and greater certainty in their competitive positions and ability to grow in a period of uncertainty and disruption. Falling interest rates provided a further boost to the tech names and other growth-oriented stocks as the cost of capital fell and a lower discount rate increased the value of future cash flows.
On a collective basis, the market capitalization of the top 5 names in the S&P 500 (Apple, Amazon, Facebook, Google owner Alphabet and Microsoft) grew by nearly 50% year-to-date through the end of November. Meanwhile, the other 495 names in the index had collective market cap growth of just over 5%.
The increased scale of the top 5 has driven greater prominence within the S&P 500, with their total weight growing from 16% to start the year to over 21% as of the end of November. As such, the return potential for the index at large is increasingly dependent on the fate of these companies.
INTEREST RATES CONTINUE THEIR DESCENT
Central banks around the world slashed short-term rates in 2020 to ease financial conditions in response to the economic shock from the pandemic. The Federal Reserve, who cut the federal funds rate effectively to zero from 1.5% in the first quarter, has guided for sustained low rates for the foreseeable future with little potential for rate hikes in the next three years to allow for continued healing of the labor market and to encourage a pick-up in inflation, which has remained stubbornly dormant.
Lower interest rates are generally supportive of risk assets, like equities, as fixed income real yields (i.e. after inflation) have become less attractive and slipped below zero in many cases, thereby forcing many investors into riskier alternatives in the hunt for yield and positive real returns. The decline in rates explains a large portion of strong equity market returns in 2020 and in 2019.
