Market Data for year-end 2020:
- S&P 500 Stock Index: 3756, up 16.2%
- Ten-year Treasury Note Yield: 0.92%, down 1.00%
- Gold: $1,898 per ounce, up 24.6%
- Oil: $49 per barrel, down 20.5%
Financial assets advanced powerfully across the board in 2020, as the Covid-19 pandemic drove unprecedented central bank easing and a record surge in the personal savings rate of investors. Between aggressive action by global central banks to inject liquidity into the financial system and investors forced to save money for lack of opportunities to spend it, markets were flooded with cash, levitating stocks, bonds, and gold. Along the way, two exogenous events helped pave the way for markets’ relentless advance: (i) a peaceful resolution to the US Presidential election, and (ii) the development of multiple vaccines with effectiveness rates better than anyone could have hoped for. Low interest rates and the heavy participation of homebound retail investors particularly boosted the shares of glamourous technology companies. To wit, the Nasdaq outperformed the Dow Industrials by 36% (43 vs 7%).
Moving into 2021, we expect more muted gains. As a starting point, stock valuations, particularly in tech shares, are near record highs only exceeded by the top of the Dotcom bubble in 1999/2000. In the meantime, Treasury bond/note interest rates (yields) are near record lows. Starting with high valuations and not having the potential benefit of significantly lower interest rates as a tailwind, we do not see stocks being able to put in another double-digit return performance.
A potential point of difficulty is that investors likely expect more from stocks, and reconciling their expectations with reality could lead to increased volatility and lower prices. Risk factors that could catalyze this process could be a slower than expected economic “reopening” due to difficulties in controlling the virus, or conversely, a more rapid economic recovery that leads to substantially higher Treasury bond/note yields. The latter risk factor would become more pronounced if the Democrats are able to take control of the Senate and enact more aggressive fiscal spending to include significant infrastructure investment.
Given the above points, we see the US stock market as represented by the S&P 500 stock index, trading in a range of 3300 to 4100 (it ended 2020 at 3756). Without knowing how the economic recovery plays out and the political composition of the Senate (although we will know after January 5th), it is difficult to forecast the path of Treasury bond/note interest rates. Gold is traditionally sensitive to interest rates, so we would expect it to track the inverse of the movement in interest rates.
We view our portfolio of high-quality dividend growth stocks having a superior risk return profile this year, as its starting valuation is substantially lower than those of the massive tech stocks that led the market in 2020, and is not significantly exposed to fluctuations in the economy.
We appreciate the business you have given us. We thank you for the continued confidence you have placed in us. Please do not hesitate to contact us with any questions or concerns you may have. We wish you a healthy and prosperous 2021.