Monthly Update
It certainly was a stellar month in the markets in November. In fact, the S&P 500 had its best month since April with a 10.8% jump[1]. The Russell 2000 was the standout, though, with its 18% spike as investors shifted to value stocks[2]. The market gains weren’t just isolated to the US, as the international stock markets were strong as well with the German DAX up by 15%, the FTSE 100 higher by 12.4%, the Nikkei rose by 15%, while the Shanghai comp was up a more modest but still solid 5.2%[3].
The big news of the month was twofold. Firstly, the results of the election pointed to a divided Congress, and secondly, it was the amazing results from both Pfizer/BioNTech and Moderna’s vaccine trials with each showing about 95% efficacy. This made investors completely ignore the still unfortunate increase in spread of COVID, which is selectively increasing the restrictions on business openings. We still have a tough winter ahead, but markets are looking to mass inoculation in 2021. In respect to the elections, we will see for sure on January 5th, when Georgia has both its Senate runoffs, if we will have a divided government, which is the hope of the markets.
Along with the rally in stocks came one in commodity prices. The Commodity Research Bureau index of different commodities rallied 10.6% with food, industrial metals, and energy prices all moving higher[4]. Inflation expectations, in response, rose along with this. Also helping was the continued weakness in the US dollar as measured by the Dollar index, which fell 2.3% in the month, and sits at the lowest level since 2018[5].
Strangely, I say as I expected the opposite, long term Treasury yields fell in the month notwithstanding the vaccine news, but as of this writing on the first day of December, they are resuming their uptrend[6]. Corporate credit rallied on hopes for a better economic outlook in 2021, but also helped by Fed actions[7].
To this, all the world’s largest central banks continued with their QE programs, along with zero and below zero interest rate policy. This has just added more fuel to the market fire.
The Stock Market
Since the March shutdowns up until the vaccine news, the rising stock market was dominated and mostly driven by technology stocks that benefited from the stay-at-home, work-from-home trend. When Pfizer first reported its great drug news on November 9th, attention quickly shifted to those parts of the market that have been most negatively impacted, such as leisure, hospitality, and travel. Also, value stocks, generally speaking, finally got a tailwind as investors became a bit more sensitive to the high valuations of tech stocks.
As nothing in the market is free, though, what the rally this year has brought us is a valuation of 19 times the 2022 earnings estimate for the S&P 500[8]. For 2021, it’s at 22 times[9]. This compares to the long term average of 15 times reported earnings, and thus, below that for future estimated earnings[10]. Consequently, there are a lot of earnings growth that we need in coming years to grow into those multiples. Certainly, low interest rates help to sustain these high P/E multiples, but I expect higher rates in 2021, as the economy improves further with the mass vaccine rollout. We just might have pulled forward a lot of future returns.
Interest Rates
With respect to interest rates, there is no doubt that the Federal Reserve will maintain its zero rate policy and $120b of monthly Treasury and Mortgage Backed Security purchases well into 2021, but at some point next year, they must start thinking about how to reverse this. After all, these policies are in place because of COVID, and with a vaccine, they are much less needed. In the meantime, we must keep our eye on longer term interest rates that are more market driven in looking for the markets message on growth and inflation. As of this writing, the 10 yr and 30 yr bond yields are just below the highest level since March[11].
The same can be said for other central banks, such as the BoJ, ECB, BoE, RBA, and BoC, which have gone to extraordinary lengths to cut rates and print money. How they respond in 2021 will be a key driver of markets and the direction of inflation that I believe will be an important component of their decision making.
The US Dollar
As stated, the US dollar resumed its downward trend and now sits at the weakest level since April 2018 against a broad basket of currencies[12]. This is partly in response to the ‘risk on’ trade around the world, but also in response, I believe, to the sharply rising US debts and deficits and zero rate and QE actions on the part of the Fed. The weaker dollar will benefit US exporters but will also import inflation and lead to a lower purchasing power of the dollar for our consumer dependent economy.
The Economy
We know the US economy has been a mixed bag but with an overall rebound definitely taking place, which should accelerate more in the back half of 2021, after we get through the upcoming winter and vaccine rollout. Housing has been a particular bright spot due to historically low mortgage rates and a demographic shift to the suburbs from some cities. Manufacturing too, particular with autos, as inventories get restocked. Online retailing has been on fire.
The real bright spot, economically speaking, has been the recovery in China and in most of Asia, where the virus was better contained and their economies saw only very limited shutdowns. The Asian region should be a key contributor to global growth in the years ahead. Europe has been through a tough time with a new round of selective shutdowns recently hurting the service sector after the summer rebound, whereas the manufacturing area has been a source of strength, due to auto’s and the need to rebuild inventories.
Conclusion
What a year it’s been, for better or worse, and we still have a month left, but there is a lot of hope that things can only improve in 2021 with the mass rollout of a vaccine. Our lives will revert back to normal, and I’m optimistic that life in many ways will quickly go back to what it looked like before. Now, for sure, some things have changed and 2020 just accelerated trends that were already in place, but human nature is one thing that never changes.
That said, if there is something we’ve seen this year it’s that the markets are not the economy and the economy is not the markets, and there can be disconnects between the two. This year certainly saw that, so even though our life styles will revert back to normality in 2021, it doesn’t mean it’s an automatic green light for stocks and bonds, because the direction of interest rates and central bank behavior could very well be the main driver instead.
Either way, I’ll repeat what I typically say, whatever the outcomes will be, it is vital that investors have a plan that suits their short term liquidity needs over the coming 24-36 months. Knowing this is covered can help cushion the balance of one’s portfolio against what I believe will be a continued choppy time for both the economy and markets. Please do not hesitate to reach out at any time with questions or for any discussion on the economy and markets.
Connect With One of Our Advisors to Learn More
