Investment Outlook and Strategy
Last year was historic in many ways – a pandemic on a scale not seen in over a century, a record-breaking decline in economic activity, unprecedented monetary and fiscal responses, and all-time highs in stock markets. As the new year commences, our hopes for a tranquil 2021 have been dashed.
No matter your political affiliations, people across the political spectrum found the riot at our nation’s Capital last week quite disturbing. Given recent reports, it is possible we have not seen the last of these events. Yet, from this jarring and distasteful uprising we see an unintended positive development – In a Congress that has been steeped in partisan gridlock, these events may well produce a rolling snowball headed toward a governing center with increased cooperation and compromise. Fostered in a highly polarized environment, fringe players at both ends of the political spectrum will likely feel center-leaning pressures that demand a more productive Congress which would serve the economy and its citizens well.
While the events in Washington last week were certainly shocking, so was the market’s reaction, as the S&P 500 posted a gain of 1.9%. A rising market in the face of turmoil is a stark example of the underlying strength of the pillars supporting this market. Fiscal stimulus combined with Fed actions result in a huge amount of liquidity entering the economy that is largely offsetting the decline in GDP caused by the pandemic. Further, given that monetary and fiscal actions generally work with a lag of six to eighteen months, the rebound in economic activity will likely gather momentum over the next year or two.
Though we find ourselves more in agreement with the bull case versus the bear narrative, there are two primary risks that we are closely monitoring. First is inflationary pressures – Due to recent changes in Fed policy objectives, higher inflation will not immediately be met with a policy change from accommodative to restrictive. Over time, asset price inflation and a tightening labor market may create imbalances earlier than generally expected, which would compel the Fed to pivot to a more restrictive policy. This would create an unfavorable environment for equities as asset prices adjust to higher interest rates.
A more subtle risk is confidence and trust in our government and corporate governance. This risk may best be explained by example – developments following the tech bubble in the late 1990s. As the structure and plumbing of the internet were being built in the ‘90s, investors clamored for anything that had a “.com” as part of its name. The speculative mania reached a turning point in March 2000 from which share prices of speculative companies declined to or near zero. Yet the damage outside of the tech sector was rather limited the first two years of the tech bust (2000-2001). The greatest declines, which included innocent, non-tech companies, was caused by two humongous accounting frauds – Enron (2001) and WorldCom (2002). These companies were well known and widely owned (Fortune magazine had named Enron the Most Innovative Company six consecutive years, 1996 through 2001). Their bankruptcies led to the demise of Arthur Anderson, one of the largest accounting firms. As a result of this pain and anguish, investors lost faith in corporate accounting and governance, and this lack of investor trust was manifested by investors selling stocks en-masse. The lack of trust was the main factor for the sharp market decline in 2002-2003. While we have no definitive insight on whether similar frauds are present today, we are closely monitoring pockets of speculative excess which create the conditions for such occurrences.
Putting it all together, we are maintaining our investment outlook at neutral.
FINANCIAL PLANNING FOR 2021 IN THE FACE OF COVID-19
Goodbye 2020 and So Nice to Meet You 2021. The warm welcome to the new year follows a year marked by the COVID-19 pandemic which caused an economic shock and market plunge in the first half of the year, and deep and lingering uncertainty for the remainder of the year. Although 2020 was unprecedented, the pandemic experience contained several important lessons for 2021 and future years.
The first and second steps to mitigate the impact from a year like 2020 are a well thought out financial plan and a cash emergency fund. While the advisable amount of funds one should keep liquid and available is best determined on an individual basis, a general guideline is between 6- and 9-months’ worth of expenses and, if you are in or near retirement, boosting this to up to 12 months of reserves is advised. If you currently do not have an emergency fund or it has been depleted, it is recommended to save a percentage of your income vs. a set amount. Once that is defined, you should develop (or update) a budget. Utilized correctly, the budgeting process helps minimizing expenses and allocating funds to your personal priorities.
Once you have a budget in place and the emergency savings account that is being funded, determine how much you can contribute to a retirement plan. It is important to build retirement funds when able, as economic shocks can cause job losses and early retirements as evident with the pandemic which left many with a smaller nest egg than anticipated.
As the number of deaths and hospitalizations continue to rise in the U.S. due to COVID-19, it is vitally important that health and life insurance needs are reviewed. Are your basic estate planning documents in place? Now is the time to review these with your adviser and attorney as well.
Lastly, it is recommended that your portfolio asset allocation be revisited and, to derive benefits from portfolio rebalancing, it is important to stick to a strict schedule in a disciplined manner. The last three years show the importance of adhering to one’s asset allocation. After negative equity returns in 2018, the following year (2019) was the 10th best year in the 93-year history of the S&P 500 Index. The strength carried into the first seven weeks of 2020, as stock indices reached record levels in late February. As the scope of the pandemic became more evident, stock prices then declined over 30% in the next month, before ending the year with double-digit returns. The point being – it is vital that investors are comfortable with their allocation and avoid reacting emotionally (fear) during periods of market turmoil.
For our clients, know that we are available for all your 2021 financial planning needs and, as always, please contact us if we may be of assistance in any manner.