Once in a Lifetime
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.
As I write this article on January 10, 2021, there have been over 90 million confirmed COVID-19 cases, of which 22.9 million Americans have tested positive. As daily new cases in the United States have escalated to a seven-day average of over 250,000 people per day, hospitals nationwide are being stressed to a breaking point.
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%.
2021 Outlook
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.
