Fourth Quarter 2020: Market Review & Outlook
Market Review
In the final quarter of 2020, U.S. equities continued to post gains for the third consecutive quarter, with positive Covid-19 vaccine news and the U.S. election result aiding recovery in the more cyclical segments of the market. The S&P 500 returned 18.4% for the year, and 12.2% in just the fourth quarter.
Value stocks (as measured by the Russell 3000 Value index) rose by 17%, posting their best quarter since 2009. The Russell 3000 Growth gained 12%, underperforming over the quarter, but continued to lead by a wide margin for the calendar year. Even more notable was the performance of small caps, with the Russell 2000 returning 31% in the quarter, nearly wiping out its underperformance versus the large cap Russell 1000 for the year.
Within the S&P 500, economically-sensitive sectors made the strongest gains in the quarter, with more defensive sectors making more modest progress. After significantly lagging for the year, Energy was the top performing sector in the fourth quarter when beaten-down shares rose as investors bet on a vaccine-fueled uptick in oil demand. Real Estate and Consumer Staples were the lowest performing sectors in the quarter.
Amid worsening pandemic conditions with sharply rising cases, deaths and hospitalizations resulting in increased lockdowns and a slowdown in economic activity, Congress finally passed a $900 billion fiscal stimulus package in late December. The Federal Reserve nonetheless maintained its supportive message, indicating the current levels of quantitative easing will likely continue.
Macroeconomic data indicates that the economy continued to grow in the latter half of the year, but later economic readings did show a slowdown in the pace of expansion, likely reflecting the new challenges created by the surge in Covid-19 cases.
Outlook
Broader market strength in recent weeks has been driven by a number of factors including stimulus optimism, the vaccine rollout, and an ongoing fiscal and monetary policy tailwind. However, there are still some overhangs, including positioning and sentiment, stretched valuations (particularly for certain names in the Technology sector), and potential concerns around vaccine distribution into next year, as the pace of vaccinations has already somewhat slowed. Inflation pressures may also be emerging, with the 10-year breakeven at two-year highs, which could set up a scenario where the Fed pulls back its support next year.
However, if vaccine progress is successful, we expect a return to “normal-ish” in the second half of the year, which could help extend the rotation that began in early November away from technology and growth leadership toward cyclical, value-oriented stocks. During the pandemic, technology and growth stocks enjoyed tailwinds from boosts to earnings and lower discount rates. These tailwinds should reverse somewhat once vaccines become more available and lockdowns begin to ease. This should allow for typical early-cycle recovery dynamics to resume, with investors rotating toward the types of stocks that benefit from a return to more normal economic activity.
We believe diversification and selection will be key in a post Covid-19 market. Despite many stocks currently appearing expensive, as the rotation toward economically-sensitive stocks continues, we are beginning to see opportunity in some of the lagging sectors of 2020, such as Financials and Industrials, and in more value-oriented stocks.
