Q4 2020 Market Commentary + Market Outlook

Each quarter, Aldrich Wealth Partner Nicole Rice and Chief Investment Officer Darin Richards provide market commentary and make projections for the upcoming quarter. This conversation is accompanied by a deeper dive into market performance and outlook, as well as featured articles on popular topics such as retirement planning and changes in interest rates.

The S&P 500 Index delivered a return of 12.1% for the fourth quarter of 2020. The closing months of 2020 were highly eventful, witnessing the distribution of COVID-19 vaccines, the conclusion of a contentious presidential election, and the passage of a sweeping stimulus package. Abroad, developed markets returned 16.0%, while emerging markets rose 19.7%. The Bloomberg Barclays U.S. Aggregate Index rose 0.7% over the final three months of the year. United States gross domestic product increased by an annualized rate of 33.4% in the third quarter. In a reversal of trend, the final quarter of the year saw a rotation into small-cap and value stocks. Global stock markets will likely continue move to move higher in 2021 as economic growth recovers. The change in leadership in the fourth quarter is a reminder that maintaining a diversified portfolio is recommended as the future does not mirror the past.

The S&P 500 Index returned 12.1% over the final three months of 2020, bringing yearly return for the large-cap index to 18.4%. Stock prices largely increased in response to positive developments regarding a pair of highly effective COVID-19 vaccines from Moderna and Pfizer. The Moderna vaccine has been shown to have a 94.1% efficacy rate. Likewise, the Pfizer vaccine, produced in partnership with BioNTech, has been shown to have a 95% efficacy rate. The quarter also marked the end of a highly contentious presidential election. President Joe Biden, who succeeded outgoing President Donald Trump, was sworn into office on January 20.

All 11 underlying sectors of the S&P 500 posted positive results for the quarter, with Financials and Energy leading the way. Respectively, the two sectors returned 23.2% and 27.8% over the quarter. Despite a strong quarterly showing, Energy remains the poorest-performing sector of the S&P 500 for the year, having lost over one-third of its value throughout 2020. Technology finished the year up 43.9% as investors showed a strong preference for stocks that could maintain growth despite the pandemic. In two reversals of trend, value stocks outperformed growth stocks, and small-cap stocks bested their large-cap peers. The divergence between small-cap and large-cap stocks over the quarter was stark. Small-cap stocks rallied and jumped 31.4%, outperforming large-cap stocks by 19.3%.

International stocks delivered higher returns than their domestic counterparts for the fourth quarter. The MSCI EAFE Index, measuring the performance of international, developed country stocks, rose 16.1%. This was the first quarter this year that the MSCI EAFE Index bested the S&P 500 Index. The MSCI Emerging Markets Index increased 19.7%, buoyed by South Korea, Brazil, and Mexico. At the close of the third quarter, developed markets and emerging markets were in negative territory. However, their strong showing to end the year brought developed markets’ annual returns to 7.8% and emerging markets’ annual returns to 18.3%. Returns were boosted by a falling U.S. dollar, which lost 4.3% against the Euro and fell 3.7% against a diversified basket of emerging market currencies.

The Bloomberg Barclays U.S. Aggregate Index returned 0.7% for the quarter, while the broader Bloomberg Barclays U.S. Universal Index returned 1.3%. Emerging-market debt and high-yield bonds were the two top performers over the quarter, respectively returning 5.6% and 6.5%. The yield on the 10-year U.S. Treasury note rose 0.25% over the final three months of the year, beginning the quarter at 0.68% and ending at 0.93%. Overall, fixed income returns were strong in 2020. Investment-grade bond yields dropped sharply during the year and boosted returns. Riskier bonds performed better in the latter part of 2020 as investors bid up prices to pre-Covid levels.

Over the third quarter of 2020, U.S. gross domestic product (GDP) increased at an annualized rate of 33.4%. The ostensibly impressive third-quarter expansion comes on the heels of an annualized 31.4% contraction in GDP during the second quarter of the year. The third-quarter expansion and second-quarter contraction are the largest recorded in U.S. history.

In its latest estimate, the Federal Reserve Bank of Atlanta predicts U.S. GDP will grow at an annualized rate of 8.7% in the final quarter of 2020. The Federal Reserve estimates GDP will decline 2.4% in 2020. For 2021, the Fed estimates GDP will increase 4.2%.

The unemployment rate ticked down slightly over the quarter, beginning at 6.9% and ending at 6.7%. Since peaking at an all-time high of 14.8% in April, the unemployment rate has gradually trended downward. The Fed estimates the unemployment rate will fall to 5.0% by the close of 2021.

Lawmakers closed out 2020 by passing a bipartisan, $900 billion stimulus package that includes direct aid to households, extended benefits to the unemployed, and loans to small businesses. Household payments could reach $600 for each adult and an additional $600 for each dependent. Payments phase out for individuals with adjusted gross incomes greater than $75,000 and married couples with adjusted gross incomes greater than $150,000. Unemployment benefits of an extra $300 per week will be sent out through mid-March. The stimulus package also extends $284 billion in loans to small businesses through the Paycheck Protection Program.

There were some positive vaccine developments, and limited distribution began at the end of 2020. Stocks moved higher on the vaccine news and unleashed a strong recovery in November as investor sentiment improved. Stock returns were further boosted by approval of another round of stimulus measures as the year concluded. Money market balances are near all-time highs, and given the low-rate environment, funds are starting to move into equities. A Federal Reserve intent on keeping rates low, coupled with massive government stimulus and more to follow, present an agreeable environment for equities in 2021.

Diversification is poised to add value in 2021 after equity returns were primarily driven by a select group of U.S. large-cap stocks for most of 2020. Economic growth is poised to rebound in the second half of 2021, and sectors that broadly underperformed during the pandemic are now relatively attractively priced and offer compelling upside if economic growth can be sustained. More aggressive areas of equity markets, including global small-cap and emerging market equities, tend to perform well in the earlier stages of an economic recovery. The outlook for cyclical sectors is strong from a growth and valuation perspective. Therefore, a broader mandate with increased diversity of style, market cap, and geography should add value relative to a more narrowly focused, large-cap allocation that outperformed in 2020.

Fixed income markets offer poor yields and little support in the event of a decline in equity markets. With interest rates near historic lows, reaching for yield by lengthening maturity or dropping in credit quality isn’t attractive. Fixed-income returns in investment-grade bonds will be limited to current yields since interest rates are unlikely to contract from already low levels. A more active mandate should help improve relative performance as there are pockets of the market that occasionally look more attractive. Nonetheless, bonds offer poor risk-return profiles. Risk-taking is better suited in the equity market until yields return to more attractive levels.