Fourth Quarter 2020 Market Commentary:
The fourth quarter was a terrific quarter for investors as equity indices in the U.S. gained 12% to 31% and overseas markets rose 16% to nearly 20%. Fixed income markets were modestly positive in the period. That brings full year returns to nearly 20% for many of the U.S. equity indices, about 8% for developed international markets, 18% for emerging markets and mid-single digit performance appreciation for aggregate and intermediate bonds. From the lows of the market on March 23, the S&P 500 gained nearly 68% which was a tremendous rebound.
During the fourth quarter we saw a rotation in sector performance, with energy leading the way higher, up almost 26% during the quarter and several other value sectors performing very well in what was a reversal from the first three quarters of the year. Even with strong performance from value sectors during the fourth quarter, for the full year 2020 growth stocks dominated. The technology sector represents nearly half the growth index versus making up only about 10% of the value index, so with technology stocks up over 42% for the year, the growth index posted outsized gains. For the full year, growth stocks were up over 38% compared to value stocks up about 3%. This extreme dispersion leaves growth stocks trading at rich valuation multiples.
Economic highlights during the quarter included strong GDP growth of 33%, on the heels of a -31% decline in the second quarter. Many strategists now predict that U.S. GDP may contract by about 3-4% for the full year which is not the collapse that many thought possible earlier in the year. Also, pandemic relief legislation was recently passed which will pump another $900 billion into the economy in the coming months. Finally, in December the Federal Reserve Board affirmed their bond buying program, stating that they would buy at least $120 billion of bonds per month for the foreseeable future. Fiscal and monetary support continue to provide ballast to the economy and the markets.
Current investment asset prices - both bonds and stocks - look relatively expensive. Fixed income remains an important part of diversified portfolios to reduce volatility but we expect returns to be muted going forward. Interest rates are at historically low levels which leaves little room for positive returns. In fact, the 10-year treasury yield was less than 1% at year end which is below the rate of inflation so the real yield for bond holders is negative. Valuation metrics for the equity market are also rich by historical measures. The key valuation metric - price to earnings - for the S&P 500 Index is at 22, a level we last saw during the tech bubble in 1999-2000. If we strip out the Index’s top 10 stocks - most of which are technology companies that have performed very well and that trade at an average price to earnings multiple of 33 - the Index looks a bit less expensive. Given such dispersion in recent performance and current valuations, we believe investors are well-served to maintain appropriate diversification and avoid too much exposure to those growth stocks that are trading at expensive multiples and may be more susceptible to a market pullback.
It’s an understatement to say that 2020 was full of surprises and volatility for investors. But patience and commitment to strategic asset allocation was rewarded as the market rebounded from its nadir in March and equities ended up posting very strong returns for the full year. This next year promises to be interesting as investors weigh the fallout from the pandemic and elevated asset valuations against unprecedented global government support through both monetary and fiscal spending.
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