I’ll spare you the summary of what was clearly a year to forget. Frankly, it was impossible to keep up with everything that has happened in the last year given the difficulties we have faced and the magnitude of what we were are still going through. Suffice it to say that it’s been a rocky start to the decade.
But the recent Capitol riot, among other things, shows us that 2021 is not a Mr. Clean magic eraser here to eliminate the stains of 2020. Regardless of the new year, we are still living in a tumultuous time, socially and economically. Rising Covid deaths, political divisiveness, skyrocketing federal debt, and an increasing wealth gap leave us in a challenging environment to navigate, to say the least.
While 2020 was disastrous for society generally, most investment classes unexpectedly saw positive returns. Using most traditional valuation methods, prices are now quite high on the whole, a scenario that typically leads to low or even negative expected returns in the near future. It is unwise to try and game this through investment timing, but if history is any indication, a focus on risk controls will certainly be rewarded.
The Fed’s swift and strong reaction to the Covid recession (paired with an already prolonged period of low interest rates and pressure to stimulate growth) has continued to artificially inflate corporate earnings and personal balance sheets in the short term, leaving the fortunate feeling richer and the global financial climate in a more precarious position. Democratic Senate wins will likely pave the way for higher federal spending and potentially higher tax rates for corporations and wealthy families. New strains of the virus are increasingly harder to control. Trade wars with China have now turned into drastic regulatory threats from the Chinese government. The combination of excessive debt loads and future inflation might not require much else to tip the scales when the time comes…
Despite all of this, I am not recommending that you hide under the covers. Knowing the reality in which we live allows us to prioritize the things that are most important and, in our case, focus on client-specific financial plans that will endure well past the current turbulence. Knowing the dangers to come makes building the proper foundation that much more vital. I am more optimistic today on short-term economic growth than I have been in over a year, mostly due to our progress in the fight against Covid and the government’s ability insistence on providing supportive measures to corporate America (targeting and efficiency are another story). Though Q1 2021 economic indicators will surely suffer from continued lockdowns, growth in late 2021 and 2022 could surprise to the upside for the following reasons:
Pent up demand from lockdowns and amassed savings will likely lead to large economic growth in the 2nd half of 2021, potentially lasting a full year as travel and entertainment lead in the recovery.
The Fed’s focus on avoiding deflation (rather than fearing inflation) means that interest rates are expected to stay relatively low for another several years (supported further by the appointment of Treasury Secretary Yellen), leading to even heavier borrowing activity and a continued boost to housing and growth assets (though not without significant volatility along the way).
The record speed of Covid vaccine development highlights the rapid growth we’re witnessing in science and technology and the power of collaboration, further strengthened by the internet and big data.
Given the current deficiencies in infrastructure across the country (surface transportation is underfunded by ~50%), Democrats’ focus on spending could lead to significant improvements and long-lasting (investable) benefits, particularly in smaller and/or alternative energy companies.
Inflation fears could be overhyped, as the economy does not rely on physical goods as much as it has in the past. Software and data have the ability to approach $0 marginal cost for additional users.
Heightened spending, leading to a weaker USD, could benefit corporate earnings outside the US.
In the longer term, technology is making us exponentially more productive, and while we have all witnessed its perils at some point in the last year, it has undoubtedly improved our lives in noticeable and investable ways. Specifically, how will education and healthcare evolve with new remote possibilities? If you don’t believe me, ask my 7-year-old nephew, who is booking zoom appointments and managing email chains seamlessly. On an unrelated note, we’ve just hired a new CTO.
A positive economic growth outlook does not necessarily lead to investment returns, however, especially when it applies to asset prices that largely already reflect this growth. Euphoria is setting in across many trendy investments (e.g. SPACs), and parabolic price increases (see Bitcoin, TSLA) have historically led to very large losses for late stage investors. How much does a tulip cost these days?
FOMO is never a reason to take undue risk, and while the timing of bursting bubbles is unpredictable, the eventual result is usually the same. These lofty valuations make it more difficult to avoid potential landmines, but also make it that much more important to stay on track with long-term goals and a stress-tested financial plan.
Wishing you and your family a happier, healthier, safer, and more stable new year. As always, let us know of any major changes in the coming year so we can adjust your unique financial plan accordingly.
Best,
Rohit