5 Considerations for 2021 Investment Strategy
In the "year of the vaccine," COVID-19 containment and Biden's policies will shape economic growth.
U.S. stocks reached all-time highs in 2020. The market’s rise illustrated dramatic differences between Wall Street and Main Street; the pain felt on Main Street included nearly 20 million reported coronavirus infections and 345,000 deaths, an estimated GDP decline of 3.5%, and about 11 million unemployed people in the U.S.
Expectations are for Wall Street and Main Street fortunes to be positively aligned by the second half of 2021, predicated on success in vaccinating much of the population. There are five considerations that investors should incorporate into 2021 investment planning:
1. COVID-19 vaccine and treatment progress will be a positive catalyst for markets, but the pandemic may not be contained for several months.
Near-term risks remain high, given the surge in COVID-19 cases and a disappointingly slow rollout of vaccines in much of the world. There are also unknown factors associated with newly developed vaccines, such as the length of protection provided by vaccines, whether vaccines prevent transmission of the virus, and the effectiveness of different vaccines against mutations of the virus. The latest surge in cases has been met with a slowdown in mobility measures and other high-frequency economic indicators.
A meaningful portion of the population should be vaccinated by midyear, leading to strong economic growth in the second half of the year. But until more of the world’s population is vaccinated, economic growth is likely to be inextricably tied to COVID-19 case counts and hospitalizations, contributing to elevated market volatility.
2. Centrists in the Senate may return to prominence.
With the slimmest of possible Democratic majorities in the Senate, President-elect Joe Biden will face constraints on his ability to enact legislative policy preferences. Biden will need support from centrist Senate Democrats, who are less likely to support the substantial tax increases and policy priorities favored by the progressive wing of the Democratic Party. Democratic and Republican centrists in the Senate may find common ground on additional pandemic relief and infrastructure spending in the early days of the Biden administration.
Some tax increases are likely, including increases in personal tax rates for individuals in the highest tax bracket and a partial reversal of the Trump corporate tax cuts. Given the slim Democratic majority in the Senate, tax increases should fall far short of the dramatic restructuring of the tax code proposed in Biden’s campaign platform.
3. U.S.-China relations will remain strained under Biden.
Biden’s approach to China is likely to be less confrontational than Trump’s “America First” approach, and he will seek support from European and other allies. Biden is more likely to recognize mutual dependency with China and the importance of Chinese revenue to American companies. He will be less focused on the U.S. trade deficit with China, which disappears once sales of subsidiaries of U.S. companies in China are included. Conflicts relating to Taiwan, technology and human rights are potential sources of friction that could create market volatility. China is here to stay, but investors are likely to welcome Biden’s more measured approach to geopolitics.
4. Equity market leadership is likely to rotate in 2021.
Market leadership rotated late last year from technology stocks to more cyclical value and small-cap stocks. “COVID-19-laggards,” including airline, hotel and energy stocks, may be the biggest winners from pent-up demand unleashed when lockdowns and social distancing are in the rearview mirror.
The initial move in many of the left-behind segments of the market comes from reduced fear of worst-case scenarios; further gains are likely when a durable and safe economic reopening is in sight. Financial stocks, a major sector within value indexes, would benefit from a steeper yield curve, moderate economic growth, and avoidance of consumer and business bankruptcies. Health care stocks should benefit from demographic mega-trends and a golden age of medical innovation, but the increasing role of government in drug pricing creates uncertainty.
Technology stocks face challenges in 2021. Heightened antitrust scrutiny, potential tax increases and moderately higher interest rates may be headwinds for the stock prices of leading technology companies. The valuations of many technology stocks may also reflect overly optimistic expectations about the pace of growth or the total addressable market opportunity for the company.
In the longer term, however, there are meaningful shifts in how people work, where they work and the speed of disruption. Because the marginal cost of scaling business over the internet can be so low, businesses can grow more rapidly and at greater profitability than they could in the past. Many of the companies that were big winners last year will continue to benefit from these mega-trends, while many of the “cheaper” companies in the market may find themselves on the wrong side of the same mega-trends.
European stocks, which are more export-centric and cyclical than U.S. stocks, should benefit from economic reopening and from fiscal stimulus that will be more meaningful in the second half of 2021. The U.K. market may rebound rapidly when COVID-19 is contained, given the conclusion of the latest chapter in the Brexit saga. Although the U.K. has done a poor job managing the pandemic, the country may be among the best equipped to acquire and distribute vaccines. Selectivity in emerging markets is increasingly important, as there is no longer a “rising tide” that lifts the entire emerging market asset class.
5. Bonds will be an unexciting but necessary counterweight to equity risk.
Short-term bond yields should continue to be restrained by central banks, while longer-term bond yields are likely to drift upward. The risk-reward trade-off in longer-term bonds is unattractive, but a well-diversified allocation to bonds remains a necessary counterweight to equity risk.
An inflation scare is entirely possible this year. There may be some temporary price spikes in comparison with last year when the economy reopens — such as in airline and hotel prices — but inflationary pressures are likely to remain muted if unemployment is elevated and the economy continues to have excess capacity. Central banks will look past temporary effects until there are longer-lasting signs of inflation. Municipal bonds should benefit from increased fiscal support and higher tax rates.
In the words of J.P. Morgan’s David Kelly, “2021 will be the year of the vaccine.” The market outlook in 2021 is tied to success with mass vaccination and containment of COVID-19; as was the case in 2020, relative winners and losers within the markets will be influenced by the degree to which safe social interaction is possible.
Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds.
Daniel is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. He also sits on the Board of Trustees for the Green Century Funds.