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Resilient households and businesses
Source: The Conference Board, NBER. Shaded areas represent NBER-dated recessions.
The U.S. economy recovered faster than expected from the epic decline in Q2, due largely to the resilience of U.S. households and businesses—resilience that will be more critical than ever in the first half of 2021. Consumer confidence was knocked lower in March and April as 22 million people lost their jobs. But confidence stabilized quickly, has improved and remains well above levels of the prior recession. Fiscal support from the CARES Act helped support the household balance sheet, and the savings rate remains elevated at 13.6%.
Source: Institute of Supply Management, as of December 3, 2020.
Business confidence has staged a truly remarkable recovery. Manufacturing received a powerful boost as pent-up demand for goods surged after shutdowns lifted in the spring. Even more remarkable has been the recovery in the sentiment of service-oriented businesses. Sentiment does not always translate into dollars and cents of consumption and investment, but it is a necessary element of recovery, and positive sentiment is our first and best defense against a double dip in 2021. It will also be the first warning sign that more fiscal or monetary support may be necessary to sustain our economy’s positive momentum.
Equity markets: Helped by liquid courage
Technicals could remain supportive, while fundamentals may be vulnerable
Source: Bloomberg Finance, L.P., FS Investments, as of November 17, 2020.
Note: Chart shows percent change in Bloomberg consensus S&P 500 EPS expectations from January 1–November 17 of 2008 and 2020, respectively.
A remarkable feature of 2020 has been the fastest bear (-34% in 5 weeks) and bull market cycles (22 weeks to recover) in living memory. This is due in part to market confidence that the current economic—and earnings—disruption is only temporary. Compared with 2008 estimates looking ahead two years, current expectations are that earnings will be back near pre-COVID levels by 2022.
Yet it is important to appreciate the amount of “liquid courage” markets have received to bolster their confidence. 175 bps of rate cuts, $3 trillion of QE, $2.5 trillion in fiscal stimulus and other facilities to support financial markets amounted to technical support that dwarfs the policy response during the 2007–2009 crisis.
The opening bell of 2021 approaches with many equity indexes at or near all-time highs. Investors should understand the technical drivers of market confidence. Yet in Q4 2021, fundamentals may well come back into focus. Until then, we expect equity markets to remain hyper-sensitive to vaccine-related news.
Fixed income: There was no more left to give
Shel Silverstein’s The Giving Tree is a classic children’s book about giving and, yes, love. I can’t help but think of the arc of this story when I think of the fixed income market in 2021. The story traces the life of a child—think of an investor—across the decades from youth to retirement. The tree gives him apples to eat, shade to enjoy, and wood to build and travel.
This has been our experience with fixed income. Like the tree, over the decades it has provided growth while also delivering income and diversification—virtually everything an investor could ask for. In the 1990s, high interest rates fueled Barclays Agg total annualized returns of nearly 8.0%. But interest rates have been on a structural decline since, and by the 2010s this had faded to only 3.75%. In the past two years, fixed income delivered its final gift: outsize returns as monetary policy and economic crisis caused long-term interest rates to plunge to less than 1.0%. As of November 30, 2020, the Barclays Agg has returned 7.3%, with 6.0% of coming from price appreciation and only 1.3% from income.
After decades of giving, the tree has nothing left to offer; it is only a stump.
Looking to 2021, interest rates are near historic lows. Traditional income will almost certainly be insufficient. A modest rise in interest rates would imply a significant decline in price that would likely offset income gains. The story has a nostalgic end. After decades of giving, the tree has nothing left to offer; it is only a stump.