Summary of 4Q/2020: Strong Performance Inspired by Vaccine Rollouts
As tiresome of a cliché it has become, we will join everyone else in saying good-bye and good riddance to 2020. However, if anyone had told us on 1/1/2020 that we would be facing a pandemic that would upend our way of life while seriously curtailing economic production, we certainly would not have expected a 16.3% gain in the S&P 500 Index. By no means a free lunch, steadfast investors who captured that gain endured a 34% drop from 2/19 to 3/23, a drop that was followed by a remarkable 68% recovery thanks mainly to the Federal Reserve’s extraordinarily accommodative monetary policies and the astoundingly fast development and approval of vaccines from Pfizer and Moderna.
On the bond side, inflation-protected bonds (TIPS) continued to outperform nominal (non-inflation-protected) government bonds. Once again, this was not due to the sudden appearance of actual inflation but rather decreases in real interest rates. The bond market’s expectation of future inflation now remains about 2% for the next decade. The 10-year Treasury yield began the year at a very low 1.9% and ended it an almost unfathomable 0.9%, thus explaining the 7.7% return for the overall U.S. bond market.
The table below summarizes the estimated returns for various asset classes based on the performance of Vanguard index funds. Please note that they do not necessarily represent the returns of the funds or portfolios utilized by Clarity Capital Advisors.
Asset Class Ticker Used 4Q/2020 Return 2020 Return
US Total Market VTSAX 14.7% 21.0%
US Large Growth VIGAX 11.4% 40.2%
US Large Value VVIAX 14.5% 2.3%
US Small Growth VSGAX 24.7% 35.3%
US Small Value VSIAX 29.3% 5.9%
International VTMGX 16.9% 10.3%
Emerging Markets VEMAX 16.9% 15.2%
US Real Estate VGSLX 9.3% -4.6%
Int’l Real Estate VGRLX 12.6% -7.4%
US Bond Market VBTLX 0.7% 7.7%
US TIPS VAIPX 1.6% 11.0%
For the fourth quarter in U.S. equities, small cap beat large cap and value beat growth. It has been a long time since we have witnessed this outcome. For the whole year, large growth (dominated by technology and consumer discretionary companies) was the winning asset class.
Among foreign stocks, international and emerging markets experienced a strong quarter, aided by a fall in the U.S. dollar. The superior 2020 performance of emerging markets is largely (and perhaps ironically) explained by China which even without a vaccine, appears to have overcome the ravages of the coronavirus.
Undoubtedly, it has been a terrible year for commercial real estate (office buildings, hotels, and shopping centers), and even the well-above-average returns of the fourth quarter still left this asset class underwater for the year.
The positive quarterly return of the US bond market was attributable to investment-grade corporate bonds. With the end of the pandemic in sight, bond investors have become more willing to take on the credit risk of corporate bonds, thus narrowing their spreads relative to Treasuries.
So what is our outlook for 2021? One crucial aspect of our investment approach is that we will never forecast a downturn in the market. Every day going forward has the same expected return, and it is always positive. To say otherwise would deny the propensity of the market to set prices so that buyers have an expected return commensurate with the risk they are taking. Nevertheless, it is worth taking note of certain market occurrences which brings us to a Wall Street Journal article of 12/28/2020, “Margin Debt Reaches a Record,” which notes:
“A strong indicator of stock-market euphoria flashed red last month. Investors borrowed a record $722.1 billion against their investment portfolios through November…topping the previous high of $668.9 billion from May of 2018. The milestone is an ominous one for the stock market—margin debt records tend to precede bouts of volatility as seen in 2000 and 2008.”
The article details how certain investors have leveraged themselves not just to buy shares in high-flying stocks like Tesla (up 691%) and Zoom Video Communications (up 451%) but options in these same companies which potentially can lose the entire amount invested in a short period of time. As Professor James Angel of Georgetown University says, “We’ve seen this play out before, and it doesn’t end well.” During the crashes of 2000 and 2008, we saw many leveraged investors get wiped out. Prudent and fully diversified investors will take a hit in a bear market, but it is one that they are equipped to absorb from being invested at an appropriate risk level consistent with their ability, willingness, and need to take on risk.
To answer the original question of our outlook for 2021, it is the same as our outlook for the next decade which we addressed here. If you would like to discuss any of the issues raised here, please do not hesitate to reach out to us at 800-345-4635 or email email@example.com.