Once in a Lifetime
According to the CDC, there are almost 130,000 Americans currently hospitalized for COVID-19 throughout the United States. Even worse, this pandemic has claimed almost two million lives worldwide, with over 380,000 perishing here in the United States. The daily death rate continues to climb not only in the United States but abroad. There are few Americans who have not been directly impacted by this coronavirus, as one infifteen Americans have tested positive for COVID-19, and one in eight hundred sixty-six have died from it.
While COVID-19 was definitely the top news story of the year, there were so many news stories that occurred in 2020. The United Kingdom officially withdrew from the European Union. It was a huge story at the time but quickly forgotten given everything that went on this year. The official impeachment trial for President Trump began on January 16th, and he was acquitted on February 5th. I’m guessing many of you forgot that this occurred in 2020. SpaceX became the first private company to launch astronauts into space. Wildfires ravaged the West Coast, with California having the worst wildfire season ever recorded. On the other side of the country, the Atlantic hurricane season had a record-breaking 30 named storms. George Floyd’s death rekindled the Black Lives Matter movement, with protests popping up worldwide. Calls for social change have impacted all of our lives. The 2020 Presidential election and the aftermath was icing on the cake for what could have only happened in 2020. Now that 2020 is officially in the history books, I truly hope we look back on it and think to ourselves that we never want to go through a year like this ever again. It was truly a “once in a lifetime” year.
The 2020 stock market year started off like any other year: with hope and promise. Yes, we’d heard that there was a coronavirus in a province of China most people had never heard of, Hubei. But most people thought that this situation would be isolated and controlled like every other potential pandemic had been controlled over the past hundred years. Little did we know a year ago what we had in store for us.
The S&P 500 began 2020 just like it had finished 2019: on an upward trend. News from Wuhan spooked the market at the end of January, as analysts worried that the regional “shelter-in-place” order would impact production for U.S. companies like Apple, Microsoft, and Intel, who had some of their industrial production coming from the region. This was quickly dismissed, as the Chinese government told the world that they had the situation under control in Wuhan.
The S&P 500 peaked on February 19th. At that time, there were approximately 75,000 confirmed cases, with almost all of the cases in the Hubei province, with just over 2,000 deaths. The only other country that had that many confirmed cases of COVID-19 was South Korea. News over the weekend indicated that COVID-19 had spread to at least 30 countries. The shock of this news began the fastest 30% or greater drop in our market’s history (see the chart below). The S&P 500 dropped from 3,386.15 to 2,237.40, or 33.92%, in just 23 trading days.
On March 24th, the House of Representatives passed the largest stimulus package in our country’s history. The $2 trillion CARES Act amounted to approximately 10% of the U.S. gross domestic product. Approximately 25% of the CARES Act went directly to U.S. citizens in the way of direct payments or unemployment benefits (see chart to the right). The CARES Act also helped prop up corporations and small businesses by incentivizing them to keep their current employees by helping pay for some of their payroll over a ten-week period.
The CARES Act stopped the free fall of our markets and started one of the most impressive recoveries in our market’s history (see chart below – green arrow). As we’ve discussed in previous Polaris Perspective pieces, 70% of historical recoveries fail after a “watershed” event like we experienced in February and March. It looked like the markets might stall in mid-April until the Senate passed an additional stimulus package on April 21st. Called the Paycheck Protection Program and Healthcare Enhancement Act, this second stimulus package provided an additional $484 billion to the existing Paycheck Protection Program (PPP). Investors realized that the government was going to take a “whatever it takes” stance to supporting our economy, which pushed the S&P 500 to new highs by the end of August (see chart below – blue arrow).
We saw weakness in the S&P 500 in September and October (red arrows), as seen in the chart below. The initial drop was the result of fear that Congress would not pass another stimulus bill to help the American people suffering from the economic shutdown due to COVID-19. The rally came as a direct result of Congress promising to pass a new stimulus bill, as was the subsequent drop when they could not come to terms for a new bill. Every election, I fear the market’s reaction to the election results. The sharp rally over a few days leading up to the election and the continued upward trend should ease investor’s worries, as Wall Street seems to have accepted and approved of the election results.
2020 was a “growth” market, with growth outperforming value across every market capitalization category. Large-cap growth outperformed large-cap value by 37.7%, the largest annual amount in our market’s history. We did see value perform better in the fourth quarter, a trend that we feel will continue into 2021.
Remarkably, ten of the twelve asset classes had positive performance in 2020, as seen in the right column in the chart to the right. This is an incredible feat, given what the world went through during this tumultuous year. Only the U.S. Dollar and commodities lost value in 2020.
Markets around the world reacted very differently to the global pandemic. Most countries put together very similar stimulus packages for their economies, as “shelter-in-place” orders were given in most countries. You can see from the colorcoordinated global chart below how each country fared during the pandemic. The worldwide
The worldwide spread of COVID-19 caused governments across the globe to make the difficult decision to close down all but essential businesses. The United States experienced the worst one quarter drop in Gross Domestic Product (GDP) in our country’s history (see graph to the right).
Unemployment skyrocketed immediately, as business cut their headcount in an attempt to keep their businesses from closing. U-3 unemployment (the official rate) quickly grew to 14.4%, a level that our country has not seen since 1937. U-6 unemployment (which includes disenfranchised workers, part-time workers, and citizens not eligible for unemployment benefits) grew to almost 23%.
Looking out at the year that sits in front of us, its all about COVID. Now that we have two highly effective vaccines from Pfizer and Moderna, it is now about how to produce, distribute, and immunize enough people to create herd immunity. Herd immunity occurs when enough of the population (typically 65%-70%) can no longer carry or pass a virus because we have the antibodies to fight off the virus. The CDC created the chart below, which shows the path to eradicating COVID through a combination of vaccinations and coronavirus survivors’ own antibody production.
We have begun the biggest vaccination campaign in world history. According to Bloomberg News, More than 25 million doses in 42 countries have been administered. A little over 8 million doses have been administered in the United States, or 2.4 people out of 100. The chart to the right shows where the most vaccines have been administered, with the darker the green, the more vaccines administered. To date, 36% of all vaccines distributed to states have been administered, with 270,000 Americans having completed the two-dose vaccination regiment.
Wall Street is predicting a strong recovery in 2021. The three blue bars in the graph below show the S&P 500’s estimated earnings for 2020, 2021, and 2022. As you can see, Wall Street is projecting that S&P 500’s 2021 earnings to be stronger than 2019’s earnings. This is not far-reaching to me. If you remember, we entered into 2020 with a healthy economy. It had cooled from the highs in 2019, but there was nothing wrong with our economy until we shut it down. While you can’t just flip a switch and make everything go back to what it was, much of our economy will quickly recover, impacting the earnings of the average S&P 500 company.
It is very rare for the stock market to be led to new highs by the same segment of the market that led the rebound and recovery. The S&P 500 is going to have to go through a transition if the markets are going to move higher, as the top 10 stocks in the S&P 500 are trading at 172% of their average price-to-earning (see to the right). We believe that leadership in 2021’s markets will be found in areas of the market that have not already seen tremendous price movements.
The S&P 500, when viewed as an overall, also looks a bit overvalued (see below). Again, a lot of this is due to the price movement in the largest companies in the S&P 500. Only two of the top ten companies in the S&P 500 are priced below the S&P 500 latest price-toearnings ratio. The trailing 12-month P/E ratio for the top ten companies is as follows: Apple – 40, Microsoft – 35, Amazon – 95, Google – 35, Facebook – 32, Tesla – 1,734, Berkshire Hathaway – 15, Visa – 47, Johnson & Johnson – 26, and Walmart – 21. Only Berkshire Hathaway and Walmart are trading below the latest reading, and only Berkshire Hathaway is trading below the 25-year average.
As we’ve discussed prior, 2020 was the strongest outperformance of growth over value. This price movement (without earnings to match the movement) has made growth much more expensive than value. As you can see from the chart to the right, the large-cap growth segment of the market is trading at almost 170% of normal. Mid-cap and small-cap growth are almost 200% of their historic normal valuation. Value stocks, while not undervalued, are trading closer to their historical norms.
In fact, relative valuations comparing value versus growth are at levels we have not seen since the late 90s. While we don’t see the same set up for a “dot-com” bubble, we do know that markets “revert to the mean.” Could growth continue to outpace value and become even more expensive? Sure. Just look at the late 90s. But then, value outperformed growth for almost a decade. When extremes happen, they tend to “snap back” to normal or even go to the opposite extreme.
Another way of looking at this is looking at linear regression. The blue line in the top part of the chart below indicates where largecap growth is historically compared to its normal trend (the black dashed line). As you can see, the blue line is above the dashed black line, meaning that it’s overvalued. The red line in the bottom part of the chart below shows large-cap value stocks. As you can see, it is below its historic trend line. In order for large-cap growth to go to its historic regression line, it will have to lose -7.66%. Value, on the other hand, would have to go up 45.66% to catch up with its historical regression line.
We are looking for leadership to come from areas that are still relatively “cheap” and also are viewed to have the best opportunity for growth. If you look at the sector detail below, the communication services, consumer discretionary, industrials, and material sectors are projected to grow substantially more than they have historically. Information Technology, which led the way in 2020, is expected to have an average earning growth year. Polaris Wealth’s investment team is always looking for areas of the market that appear to have the best opportunity “growth at a reasonable price.”
This does not mean that we will be abandoning investing in areas like information technology, financials, or health care. We believe that a lot of the “work from home” / COVID recovery trend will continue into the 2021 markets. We are just unwilling to pay nosebleed prices for companies that are priced for perfection. If for any reason these expensive companies disappoint Wall Street, they will pay for it dramatically in the form of a gap down in price. This means that we will have to be even more selective with our quantitative screening, technical research, and fundamental research to find the best companies at the most reasonable prices.
We encourage our Polaris Wealth clients to continue to consider increasing their equity exposure in their portfolios. The bond market is positioned to provide very little to the average portfolio. As you can see from the chart to the right, the 10-year Treasury is yielding 0.93%. This is a historically low yield. What is worse is an investor is losing buying power to inflation, now at 1.65%. An American investor in 10-year Treasuries is losing 0.72% per year (0.93% – 1.65% = -0.72%). Polaris Wealth has been forced to get inventive with our bond holdings for clients, buying convertible bonds, high yield bonds, preferred stock, and international bonds.
The Polaris Wealth investment team is excited for 2021. We think that it is going to be a “stock picker’s” market. There are a lot of landmines out there that will hurt the inexperienced investor or the professional that is unwilling to decouple from their technology trades. We feel this is where we add the most value to our portfolios. We believe that value will come back into favor or at the very least not underperform growth at levels we’ve never seen before.