By David T. Mayes
In so many ways, 2020 will be a year none of us will forget, as much as we might like to.
Financial market history will show 2020 as a year that saw the shortest bear market on record as the initial outbreak of COVID-19 and fears about its rapid spread triggered a 34% decline in the S&P 500. While this stock price drop was on par with the average bear market, the downturn ended in just over a month’s time, well shorter than the average bear market’s 14-month duration.
After peaking in February, the S&P 500 Index was back to setting new highs by August. In fact, after hitting their bottom, both the S&P 500 Index and the Dow Jones Industrial Average recorded their best 100-day advances since 1933.
How could stock investors be so optimistic with unemployment spiking to double-digit levels? Some of the optimism can be attributed to government efforts to backstop the economy. The Federal Reserve reduced short-term interest rates to near zero and took steps to ensure that financial markets did not enter a pandemic-triggered freeze.
In addition, Congress stepped in quickly to pass the $2 trillion CARES Act, a fiscal stimulus package that far surpassed the support provided to offset the impacts of the 2008 financial crisis. Consequently, the record decline in Gross Domestic Product in the second quarter was followed by a record rebound in the third quarter.
One key to note is that the headline gains in the major US stock market indexes during most of 2020 were concentrated in a handful of technology companies, namely Facebook, Amazon, Apple, Netflix, Alphabet (Google) and Microsoft. This helps explain some of the disconnect between the stock market’s apparent optimism and the weak unemployment numbers.
These technology firms were beneficiaries of the dislocations being driven by the pandemic, while other industries were suffering. For most of the year, the gains in technology stocks masked weakness in other sectors of the market.
This picture changed dramatically in the fourth quarter. As the availability of the COVID-19 vaccines became imminent, the stock market rally broadened out as investors renewed their interest in smaller company and dividend-paying stocks.
The Russell 2000 Index of small company stocks posted a return of 31.4% during the last three months of the year compared to a return of 12.2% for the S&P 500 Index. This year-end rally in small-cap stocks put their total return for 2020 at just over 20% compared to the S&P 500 Index’s 18.4% return. In addition, large-cap value stocks finally outpaced large-cap growth stocks, and by a wide margin.
In the fourth quarter, the iShares Core S&P US Value ETF posted a return of 15.3%, well ahead of its growth counterpart’s 11.2% return. International stocks also saw a strong fourth quarter with the MSCI EAFE Index recording a 16.1% return. These emerging trends, should they continue, bode well for the performance of diversified stock portfolios that tend not to be concentrated in a few technology names.
The economy still has a long way to go to recover to its pre-pandemic levels but there are some promising trends that should continue with the vaccine rollouts. Employment remains well below its peak, but about 12 million of the 22 million jobs lost between February and April have been recovered. Retail sales have rebounded past pre-pandemic levels, and, in aggregate, households remain in good financial shape to continue spending.
The household financial obligations ratio (the amount a household pays for recurring monthly expenses such as mortgages, car payments, utilities, and real estate taxes) hit a record low of 13.6% of disposable personal income in December. Indicators are also showing strength in both the manufacturing and service sectors of the economy.
Perhaps the best lesson from 2020 for investors is a reminder of the difficulty of market timing. Accurately predicting the best time to be in or out of stocks or to over-emphasize specific sectors of the market or regions of the world is not possible because you must be right twice – once on when to get out and once on when to get back in.
Because market sentiments change unexpectedly and often quickly, patience and holding a diversified portfolio and periodically rebalancing, rather than chasing returns into the hot stock, sector, or asset class of the day, is a better approach to achieving solid long-term returns.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Agent at Three Bearings Fiduciary Advisors, Inc., a fiduciary financial planning firm in Hampton. He can be reached at (603) 926-1775 or email@example.com.