Points of Consistency

Market Commentary | Fourth Quarter 2020

In our final 2020 commentary, we reflected on the practice of simplifying annual market growth (or decline) to a single percentage return. Doing so strips out useful context. Instead of complexity, we have only a sterile numerical value, constraining our ability to see what might be ahead. A simple method, for sure, but one that tempts investors and advisors alike to expect the future to be a straightforward continuation of the recent past.

To be down in the weeds of economic data, and attempt to anticipate short-term stock price movements based on jobs data or recent consumer price index readings does not provide a useful view either. Short-term prices can be influenced by these technical data points, but they are also driven by less concrete factors including investor emotions, the social and political environment, and differing views of future growth. This confluence makes it impossible to pinpoint true value in the short-term. Rather, the value of an equity investment develops and grows gradually over time, and tolerating the price swings along the way is how you earn a higher return than you would investing in an asset with a fixed yield. 

The point to participating in equity investing in the short term is simply that: to participate. Insightful observations about short-term challenges – even a pandemic – do not necessarily translate into an obvious longer-term strategy. As time passes, events like the pandemic become short-term events in the context of an investor’s lifetime. 

Instead of dissecting the short term, we look for points of consistency that can give us confidence in the longer-term growth trajectory of stock prices. If we find innovation, development into new markets, collaboration among companies, and consumer engagement with products or services, we can affirm our optimism for future growth.  As investors, we may encounter detours on the road ahead, and yet, we hold the conviction there will be gorgeous scenery along the way.

As we enter 2021, we expect to encounter potholes as well as progress, with an uneven path to global economic recovery over at least another year or two. Still, more fiscal stimulus is now on the table, and entities at every level are trying to improve the rate of vaccine distribution. 

This juxtaposition evokes the market truism that investors “buy the rumor and sell the news.” In 2020, this meant a focus on the “rumor” that additional stimulus and efficient vaccine development and distribution would lead to a certain if not swift economic rebound. Investments were made on hopes for the future, not the facts of the present. Prices in specific sectors rose to nosebleed levels, and the overall S&P 500 index finished the year with a staggering +18.4% return; the emerging markets index including China grew by a comparable +18.3% return.[1] Without context, these simplified return numbers could lead one to believe that 2020 didn’t experience the significant disruptions to economic activity that was a reality globally. In fact, the market was pricing in future growth, and the coming year will determine if the “news” of actual recovery matches investor expectations.

A slower vaccine rollout, a persistent stretch of high unemployment as businesses focus on lean operations, a tepid return of consumers to all sorts of gathering and travel: all of these plus other things we can’t now anticipate may lead stock prices in 2021 to drift lower not higher. Investors may emerge from the fog of pandemic distortion and realize that economic growth is improving, but not at a pace that justifies current market prices. This simply means that the market’s usual characteristics of uncertainty and volatility will be in full bloom while we wait for longer-term economic growth and innovation to get solid traction.

The bond market often leads the stock market in recognizing the risk of inflation, and in the early weeks of 2021, it is doing just that.  Bond yields are increasing, meaning that prices are decreasing because investors expect interest rates to increase in the future due to the expansion of debt-funded stimulus under the incoming government. The yield on the 10-year U.S. Treasury rose again this week, to approximately 1.13%, the highest yield since last February. Bond investors are demanding higher yields as compensation for the continuing risks of economic recovery.

In the near-term, wildly bid-up prices in certain industries have become detached from fundamental considerations. A prime example is Tesla – which is currently worth more than Ford and GM combined, despite accounting for less than 1% of the global auto market and facing increasing competition as the other auto majors ramp up their own EV production. Irrational exuberance can be seen elsewhere as well: there were 480 IPOs in 2020 as companies rushed to capitalize on high prices, and retail investors speculated by increasing their option trading 8x over 2019 levels.[2]

The dramatic jump in stock prices over recent months has effectively “borrowed” from future returns. In 2021 there is likely to be considerable economic and global health recovery, yet equity prices may be vulnerable to a near-term correction. Overall that remains a healthy outcome as long as we have a longer-term trend of upward growth with expansion of renewable energy, re-shoring of certain areas of manufacturing, and innovation in genomics and healthcare.

At North Berkeley, this means we will continue to emphasize disciplined rebalancing by trimming stock allocations as they grow beyond target levels, and buying stocks if market prices hit an air pocket and drop from current levels. Whether or not 2021 can deliver on all that investors are hoping for, our goal remains the same: stewarding our clients’ portfolios such that they feel confident in their own long-term financial resiliency, their liquidity for short-term surprises, and an alignment of their financial life with their own values and vision of the future

¹ Morningstar Direct market data

^{2 https://www.seeitmarket.com/2021-u-s-economy-early-in-new-cycle-or-late-cycle-still/}