The world headed into 2020 with guardedly optimistic expectations, despite slowing economic growth. By March, that had changed dramatically. The COVID-19 pandemic struck, leading to a shutdown that threw the economy into a deep, but brief, recession virtually overnight. Equities and other risk assets entered into a steep downturn but bottomed relatively quickly, before turning sharply higher even as economic conditions remained in doubt.
Nearing the end of 2020, the economy has rebounded sharply but the pace of recovery is slowing as another COVID-19 wave is rising. However, despite the near-term risks, global equity markets appear poised to finish 2020 on solid footing.
Where does this leave investors? How should investors consider their options today given the current risks and the unknowns around what tomorrow will bring? We’ll start by examining the current outlook through multiple lenses that focus on what we believe to be the key risks and catalysts for the market in 2021 and beyond.
The near-term outlook for the economy has weakened as growing restrictions are announced to attempt to constrain the spread of COVID-19. Promising news on the availability of an effective vaccine and the likelihood of additional fiscal support from Washington, D.C. could be positive catalysts for not only a resurgence in growth, but the establishment of a more durable post-pandemic recovery. While the near-term risk posed by further shutdowns weighs heavily on the near-term growth outlook, the economy is expected to rebound sufficiently for the economy to grow at an above-trend pace over the course of 2021.
Additional fiscal stimulus will be needed in response to the resurgence in COVID-19 cases and the policies enacted to combat its spread. While there’s been bipartisan support for another bill in concept, differences in terms of size and scope had hobbled progress until recently. Will the two parties be able to strike a compromise in a reasonable time frame? Recent activity has lifted hopes for a deal, but questions around its timing and scope remain unanswered.
Elevated unemployment, low inflation and an economy that will take time to fully heal will keep the Fed in an accommodative mood for the coming year and beyond. The central bank will almost certainly hold short-term policy rates near zero for an extended period, while remaining active in its bond purchasing activities to suppress long-term yields as well.
With the Fed acting aggressively to keep rates low to support growth, bond yields are likely to also remain low over the next few years. Investors will have to balance competing diversification and income goals in structuring their bond portfolio. Maintaining an actively managed, high-quality core allocation with measured exposure to higher-yielding sectors can provide that balance for many investors.
Despite near-term risk from COVID-19 and further lockdowns, several positive factors should support global equities over a multiyear timeframe. Momentum in big tech stocks could persist for some time, but changing conditions, attractive valuations in other parts of the equity market, and the transition to a more durable economic expansion should provide a tailwind to cyclical sectors, small caps and foreign equities. In the near term, the risk presented by COVID-19 and resulting negative economic impact could contribute to market volatility. Even so, a more durable post-pandemic expansion and accommodative fiscal and monetary policy should provide underlying support for equities.
Most investors are able to achieve their financial goals without an allocation to alternative investments. But investors who are willing and able to accept the complexity and restrictions of alternatives may benefit from lower portfolio volatility, enhanced returns and an expanded investment opportunity set. When viewed against expectations for lower returns for stocks and bonds, alternative investments can enhance the risk/return profile of a portfolio.
Outlook: Investing in Uncertain Times
So, at a time with so much uncertainty on the horizon, what’s the bottom line for investors?
First, it’s important for investors to not lose sight of their investment time horizon, which for most isn’t measured in months or even years but in decades. The opportunity in out-of-favor sectors, market cap segments, and regions appears increasingly favorable, even as momentum has carried more expensive areas of the market higher. The catalyst for a change in sentiment has been missing so far; however, there’s growing evidence that may be changing.
To benefit, investors will need to look through near-term sources of uncertainty. Speculators may buy stocks today as a bet on near-term performance; investors should adopt a long-term view, acknowledging it’s impossible to predict what will happen in the near term. Creating an investment policy statement that encompasses the investor’s goals, risk tolerance, return needs and investment time horizon can provide a disciplined framework for the implementation of a suitable portfolio and for ongoing investment decision-making.
Investors also need to tune out the day-to-day noise. During periods of uncertainty, investors may understandably be skeptical, concerned or afraid. Beware the refrain that “this time is different.” In truth, every time is different. Every crisis, every risk to the market over time differs from the last. And while every year may not see new market highs, the capital markets remain on a long, unambiguous upward path over time. With hindsight, it’s remarkable how quickly volatile periods fade from view against the long-term advance of the markets. The key is having a plan to guide one’s decisions, particularly when more challenges arise.
Rather than trying to time the markets in response to election outcomes, near-term economic concerns, bubbly valuations or the next “unknown-unknown” development that may lift stocks to new highs or knock the market off course, we offer the same steady advice: Look past the noise, and stay focused on the long term.
From this vantage point, investors can see beyond the current period of doubt to a bright future filled with possibilities. Uncertainty about the risk created by the COVID-19 pandemic, the changing political picture or the slowing economy may represent a near-term dark tunnel, but we firmly believe that there is a bright light in sight as the potential for an effective vaccine becomes reality and pent-up consumer demand provides a fresh lift to the economy in due time.
Keep your eyes on the horizon. There are better days ahead—for the capital markets, for our country and for the world.
Jim Baird is a CPA, CFP®, CIMA®, CIO and partner with Plante Moran Financial Advisors.