The year 2020 and the start of 2021 will be burned into the collective consciousness for quite some time for a myriad of reasons and given this we probably shouldn’t rehash every headline here. However, from an investment standpoint we can summarize 2020 very simply as:
The global economy was presented with many hurdles, due to these hurdles corporate earnings were significantly impacted yet the equity markets – as measured by the S&P 500 – posted a well-above-average total return of 18.4% for the year.
Focusing on the first two, the latter seems extremely improbable as we have been conditioned to believe that equity returns follow economic and earnings growth, which, in the long-term tends to be true. However, in addition to current earnings growth and quality it is also the expectation for future earnings growth that has a strong influence, and clearly this was the case in the second half of 2020. The question now becomes with the vaccines beginning to bring the light at the end of the long pandemic tunnel into view, will current and projected earnings growth be enough to sustain this rally into 2021 and beyond?
With the Georgia runoffs now in the bag and the November 2020 results certified, hopefully the elections can now be put to rest which is not what equities have been doing since November. The S&P 500’s return both during election week (7.32%) and post-election through the end of the year (11.81%) were records and the index closed the year at a record high. These moves have propelled the S&P 500 to a trailing P/E (price per earnings) of 30.3 which is approximately 61% above its 20-year average. Projected earnings growth for the S&P 500 for 2021 are on the order of 25% which, if accurate, would still place the S&P 500 about 29% above its 20-year average P/E assuming no price movement in the benchmark. This by itself does not portend a significant selloff for equities is imminent but at some point, as always, price and valuations matter and investors need to be cognizant of this.
On the plus side, unprecedented monetary and fiscal stimulus are in place and should remain in place for quite some time. This will probably grow as the new administration takes its seat in the coming days, but it is doubtful that everything they attempt to implement will be constructive for equity prices. Refocusing on the positive, there is a tremendous amount of savings that have been built up by Americans and its potential is coiling like a spring that consumers will surely deploy as the global economy begins to fully reopen. However, to be clear, that reopening will be choppy, full of potholes and most likely not as quick as most would like; but we are confident it is coming in 2021. In addition, there are many things to be positive about over the horizon and this is driven by several factors including innovation. Innovation in how we work, how we learn, how we utilize energy, how we buy and transact, how we solve medical problems and how we spend our leisure time, to name a few.
Given this we continue to remain optimistic about the prospects for equity prices in 2021 as there are many worthwhile pieces aligning. However, we feel it is important for investors to enter the year with slightly muted expectations compared to recent results. Weighing the current environment, returns on the order of 8-12% for the S&P 500 in 2021 seem reasonable to us, which is clearly below the return of 31.5% for 2019 and 18.4% for 2020. In addition, considering the plethora of hurdles still facing the global economy, a setback of 5% or even 10% is potentially in the cards for the S&P 500 in 2021. To help insulate against this we continue to encourage investors to stay diversified and focus some of their attention on themes that have underperformed the S&P 500 over the last 10 and 15 years and offer more value. These themes include the cyclical sectors and industries, international stocks, including emerging markets, value stocks, including quality dividend payers, and smaller capitalization stocks.