Published on Jan. 8, 2021
December 2020 | Equity Commentary
Stocks finished the year on a strong note, as the S&P 500 gained 3.7% for December and about 11.7% for the 4th quarter overall. We believe investor enthusiasm was largely driven by the FDA approval and initial roll-out of two highly efficacious COVID-19 vaccines, which have enabled markets to begin to price in a return to normalcy over the next several months. While coronavirus cases continue to surge and economic conditions may deteriorate in the near term, we remain optimistic that the new vaccines, alongside of copious amounts of fiscal and monetary stimulus, can act as meaningful support factors for the stock market.
Economic data appears to have cooled in recent weeks, though relative to economist expectations we think the economy has held up fairly well in the face of sharply rising coronavirus cases. Housing continues to be a bright spot, as the National Association of Home Builders housing market index remains close to all-time highs, and single-family starts and permits are at their best levels in over a decade. Other areas of the economy, however, have faced greater challenges. Weekly unemployment claims, which had been in a declining trend since the summer, ticked up again in December, suggesting that the increase in COVID cases and related shutdowns are once again negatively impacting employment. The monthly payroll data for November was aligned with this view, coming in well short of expectations and meaningfully below October’s reading. Retail sales also weakened in November, falling by 1.1% on a month-over-month basis, missing the consensus call for a 0.3% decline.
Coming off a robust rebound in the 3rd quarter, we expected that the economy would decelerate during the 4th. We think that the key issue for investors was not whether growth might slow, but rather to what extent. Given the sharp spike in COVID cases and the government’s inability to agree on a new fiscal stimulus bill until the end of December, we were quite pleased with the resiliency of the economy and are optimistic that it may continue to surprise to the upside into the new year. We view the $900 billion pandemic relief bill which was signed into law late last year as a key support factor for the economy, and think that it will help to sustain business activity over the next few months until vaccines are expected to be widely available. The bill should help to support consumers and small businesses through stimulus checks, enhanced unemployment benefits, and emergency lending programs. In our view, the prior stimulus bill had a significant impact during a period in which the economy was in a weaker state than it is currently, and we are therefore optimistic that this latest stimulus package can help to turbocharge an economy which has already been showing signs of resiliency. As well, the Democrat sweep of the Georgia senate election runoffs may result in additional fiscal relief, which, if it comes to pass, should provide even more support for the economy.
The Federal Reserve held its latest FOMC meeting last month, and our key takeaway is that while it slightly raised its economic forecast, interest rate guidance remained the same. This is significant, as it is an early indication that the Federal Reserve is staying true to the new policy framework announced last summer whereby it may allow the economy to run hotter than it previously would have before beginning to raise interest rates. We view this shift in strategy as dovish, and therefore were encouraged that this latest upgrade to its economic projections were not accompanied by a change in interest rate guidance. We think that this lends credibility to the idea that the Federal Reserve is in fact committed to adopting its new, more flexible, policy framework.
As we look ahead, COVID remains a key risk factor for markets. We are concerned that a new strain of the virus, which may be more contagious, could lead to more lockdowns and further inhibit economic activity. It is therefore that much more important that vaccines are rolled out expeditiously, though thus far this has not been the case. The initial rollout has been slower than expected, perhaps not too surprising given the challenges inherent in public-private partnerships along with the logistical complexities of this endeavor. We are optimistic, however, that the pace of the vaccination initiative will improve over time. Looking out over the medium term, there is some risk that a full reopening of the economy, pent-up demand, and the lagged effects of fiscal and monetary stimulus could lead to an economic boom causing inflationary pressures and sharp increases in yields, ultimately weighing on stocks.
Despite these significant risk factors, we see reasons for optimism. We think that the latest fiscal stimulus package can go a long way towards helping to sustain economic activity until vaccines are more widely available. As well, the FDA may approve additional vaccines for emergency use in the coming months, which would help to shorten this interim period of heightened economic vulnerability. The Federal Reserve continues to inject liquidity into the financial system through its $120 billion of monthly asset purchases, and has pledged to continue doing so until it sees substantial further progress towards its goals of maximum employment and price stability. The use of the word ‘further’ in its statement is noteworthy, as it clarifies that the Federal Reserve is looking for substantial progress from current conditions, as opposed to those during depths of the recession. In our view, it is therefore safe to assume that the Federal Reserve will continue to keep monetary policy highly accommodative for the foreseeable future. We expect that this combination of fiscal and monetary stimulus may continue to act as powerful tailwinds for stocks, particularly against the backdrop of an economy that has shown impressive resiliency, and optimism that we may finally be approaching the end of this pandemic-plagued period.
As of December 31, 2020