McCarthy & Cox News and Articles
2021 Market Outlook
Most annual market outlooks involve outlining potential risks that could send stocks lower – geopolitical tensions, political upheaval, an overly aggressive Federal Reserve – and in fact, our 2020 outlook featured these very items. What it didn’t mention was a global pandemic that would bring everything to a screeching halt.
Covid-19 was unlike anything we have previously seen. Entire industries were shut down. Unemployment skyrocketed. Restrictions kept people homebound. And obviously, the economy suffered huge damage. Only recently have we started to see real signs of recovery.
And while Covid-19 is still spreading, several vaccines are becoming widely available. But how do we bridge the gap between now and widespread immunization? No one knows how best to do this, but at least we have a timeframe for things to return to whatever the “new normal” is.
The economy ebbs and flows. There are good times and times when things aren’t so good. These “good” times and “bad” times fluctuate around some long-term average, much like the temperatures fluctuate between milder in the Summer and colder in the Winter each year. Unless you live in Ohio - we simply fluctuate from cold to colder with a few weeks of warmth scattered in… This is known as the business cycle.
When things are good, consumers invest more because they feel confident about the future. We purchase a new car, dine out more, or take an extra vacation. Companies may recruit new staff, build new buildings, invest in technology, etc. to create more products and services. Their expenses go up, and these expenses are passed on to consumers. Consumers slow their spending at some point, and companies cut prices to get rid of excess inventory. They may also lay off workers and sell some of these new buildings. When we hear about this, we aren’t so confident about the future anymore.
Typically, it takes years for an economy to go through an entire cycle, but we went through much of it in early 2020 alone. We had been in “good” times for a decade, but the pandemic changed that quickly, throwing us into a recession. Just as quickly, however, governments and banks around the world intervened, pushing us back into the early phase of a new business cycle. And the last time the US economy was in early cycle was after the 2008-09 housing crisis – which only recently ended with the pandemic.
There is already a lot of money sitting on the sidelines, considerably more than at the end of the housing crisis. And with savings account and CD rates where they are today, investors may be inclined to put that money to work in the equity and fixed income markets.
There are several themes we'll keep an eye on as we move throughout 2021. How these play out will likely have a lot to do with how the markets perform this year:
- The road to recovery will likely be uneven.
- Accordingly, how do we position portfolios?
- With rates close to historic lows, where do we find income?
- And finally, what impact will Covid-19 have on the remainder of 2021?
It is likely that the road to recovery will be uneven; a scenario where stocks go up in a straight line without any pullbacks is difficult to imagine. Although the recovery is focused on favorable fundamentals, there are plenty of risks that could turn things south in a hurry, and there is certainly "headline risk". After all, few had heard of COVID-19 at this time last year. An uncontrollable resurgence of the virus is among the threats that we think should most worry equity investors. We have recently heard about virus mutations. And even though we have several vaccines, it could take longer than planned to deploy them to enough of the global population to dampen the spread of the virus. All bets are off if major issues arise with the vaccines.
Rising inflation is another possible risk that is not getting any attention. Although our base-case scenario is not a rapid price spike, the ingredients for an inflationary surprise are present. The amount of liquidity that monetary stimulus offers is staggering. The level of the Federal Reserve's balance sheet compared to gross domestic product (GDP) peaked at just over 26 percent in the years immediately after the housing crisis. It was 40 percent this past June. As the Fed sits on the sidelines, if economic activity gains too much traction, prices may easily outrun attempts to rein in them.
In March, global central banks poured USD 4 trillion into the world financial system and have since added more. This year, the United States alone is forecast to run a deficit approximately equal to one-fifth of the gross domestic product. Although it may have been appropriate for this drastic degree of assistance, it is obviously not sustainable. It is unclear how and when the withdrawal of this underpinning would play out.
These are just a few of the many risks in the year ahead, and we will certainly be looking at another year of increased volatility as these ebb and flow. One of the things we were most convicted of when we entered 2020 was frequent rebalancing to take advantage of increased volatility, and we still feel that way. Rebalancing is a crucial but perhaps undervalued aspect of portfolio management, the significance of which has been highlighted by the extreme volatility of the market in recent quarters. Moreover, it is an automatic way to take advantage of the mantra "buy low sell high." We believe that, precisely when volatility spikes, active managers can add significant value.
What else can we do to take advantage of potential opportunities, besides frequent rebalancing to take advantage of increased volatility? We will look closely at value stocks, smaller capitalization firms, and equity and bond markets in emerging markets.
In equity investing, growth and value are two fundamental approaches, or styles. Growth investors are looking for businesses that offer strong growth in earnings, while value investors are looking for stocks that appear to be undervalued on the market. Since the two styles complement each other, when used together, they add a layer of diversification.
One of the biggest disparities ever between growth and value strategies occurred in 2020. And while growth and value tend to have prolonged periods of varying performance compared to each other, the length of the 2020 cycle was uncharacteristically long. Many of the winning stocks were those that provided technology to work from home, telemedicine, online learning, e-commerce, video streaming and social networking when the pandemic hit. The gap between growth returns and value companies was further strengthened by this. Because of this, relative to their growth counterparts, many value stocks became extraordinarily undervalued.
More recently, signs of a rotation back to value have occurred. Much of the underperformance of value earlier in the year can be attributed to the fact that the financial and energy sectors accounted for a substantial proportion of the S&P 500 and that both sectors were severely lagging during the shutdown. Value stocks have begun to shine as the global economy has re-opened, as they tend to do well early in an economic recovery.
Small cap stocks are also favored by the early cycle environment. The recession is likely over, which means we are in the early stages of a new business cycle, and a new bull market. In comparison to their large cap counterparts coming out of recessions, small caps have historically performed well. The tale is the same as coming off major bear market lows where, on average, during the first year of bull markets, small caps outperformed large caps by about 15 percent. True to form, small caps have outperformed large caps by more than 10 percent since the March 23 low.
In 2021, Emerging Markets equities will also benefit from a cyclical global upswing and the Biden administration's more predictable U.S. trade policy. Investment flows into Emerging Markets equities should underpin these variables. Also, while China and parts of Asia were initially the hardest hit by the pandemic, they were also the first to recover and, when restrictive measures were lifted, saw remarkable rebounds. While at some point this momentum may fade, governments will continue to provide support. Given the accommodative environment, both emerging market equities and fixed income appear attractive, which is a nice segue to the next area of focus: where do we find income with today’s rates?
Questions are rightly being asked about the effectiveness of bonds as a hedge for equity risk. This has become more valid as the prospect for an offsetting rise in bond prices diminishes when yields have little room to fall further. Bonds still offer relative capital stability, however, and at lower maturities where duration risk (sensitivity to changes in interest rates) is smaller should continue to offer income without excessive capital volatility.
For investors concerned about the impact of low interest rates on Treasuries, diversified core fixed income can still act as portfolio ballast in volatile markets. In simple terms, investors could lower credit risk in an area with lower return potential like short-term bonds, which may help balance higher risk in an area with higher return potential, such as floating rate bank loans.
This ballast allows us to seek out opportunities within equities, namely the prime potential beneficiaries of the economic recovery, such as emerging market equities and US small caps. Additionally, with interest rates likely to remain low and rangebound, we can look for opportunities in other non-core areas such as credit and emerging market debt. Emerging markets bonds, both government and corporate, have attractive yields and should benefit as accommodative monetary policies enhance global liquidity.
And how will Covid-19 and Geopolitics affect 2020? You may be reading this from a home office or temporary workspace that is starting to feel permanent. You may also be working odd hours to accommodate a child’s remote school schedule. You are probably wearing casual clothes nice enough for video meetings and answering your door to accept deliveries of food and other online purchases.
Eventually, we will return to something we consider normal, but some of the ways we learn, work, shop and entertain ourselves will never be the same. This transformation played out in various investment themes in 2020, and we will likely see some of them carry over to 2021.
An ongoing pandemic, a weakened economy and a deeply polarized country are facing President-elect Joe Biden. A more predictable U.S. approach to trade, foreign affairs, and working with allies is the principal geopolitical implication. It is likely that tensions with foreign countries will ease, especially over trade. The markets should be helped by this, as well as US support for multilateral debt relief efforts.
In summary, we believe 2021 is shaping up to be amicable to stocks. However, equity market gains may become more dispersed as we work through the recovery. As its adoption has been accelerated during the pandemic, technological innovation should contribute to equity returns. And many of the areas that lagged during the pandemic should rebound as we move towards a full, global reopening. Leading companies may emerge from the crisis in an even stronger position as they seek acquisition targets and capitalize on competitor missteps.
To be certain, the economy and markets could be affected by another wave of Covid-19. Nor is the coast clear for a regulatory environment that is business-friendly or a resumption of unfettered global trade. However, considering the nature of this downturn along with the performance of the global economy well before the pandemic, we can look back to 2020 as the advent of a new bull market cycle, the last five of which have lasted over five years each.
When fear and uncertainty are high, markets go down. The reverse is also true. Each day brings us closer to the end of the pandemic and closer to a more certain future, one where we can hopefully find some semblance of normalcy. As such, we will view any pullbacks as buying opportunities, making modest bets around our long-term, strategic allocations. As always, a diversified portfolio and long-term view still offer the best route to reach financial goals.
- The McCarthy & Cox Team
Authored by Wes Bean, Director of Investments
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged, and investors cannot invest directly into an index. Market references refer to the S&P 500 Index, a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. Fixed Income or Bond market references refer to the Barclays Capital Aggregate Bond Index. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Commonwealth Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.
Press Release | August 31, 2020
McCarthy & Cox Charity Outing a Success
Held on August 20, 2020, the 8th annual McCarthy & Cox Charity Golf Outing was a huge success. Although COVID-19 brought about some changes for the event this year the weather for the event was beautiful. Through many generous donors, this year’s outing raised a record-breaking $22,965 for two charities; The McCarthy & Cox Cares Fund and The Elizavèta Fund, both of which are housed at the Union County Foundation.
The McCarthy & Cox Cares Fund was founded in 2013 by Tom McCarthy & Jim Cox to assist seniors, youth, and emergency needs in Union County. To date, the Fund has donated more than $43,000 in the community. The Cares Board consists of five current McCarthy & Cox clients who independently review grant requests from the community. For more information, visit McCarthyandCoxCares.com.
The Elizavèta Fund was founded in 2014 by Jim and Faye Cox to help families with the financial burden of adoption costs. Jim & Faye adopted their daughter, Caroline Elizavèta, from Russia back in 2011. Throughout that process, they came to realize the financial and time commitment that adoption requires and decided to seize the opportunity to help others with the undertaking. Over the years, the Elizavèta Fund has granted over $65,000 to assist 16 families, aiding in the adoption of 17 children - with at least two more on the way. For more information, visit ElizavetaFund.org.