2020 Fourth Quarter
How in the world could stock indexes be up in the year 2020 with so much misery in the US and around the world? There have been 399,000 COVID-19 deaths in the US alone. Moreover, we have experienced relatively high unemployment due to concerned consumers staying at home – they are not traveling and have certainly cut back on eating out at bars and restaurants. So how could the market be up during this time? The answer is that the stock market is a predictor. I have found that the stock market predicts what it sees 6-12 months out and, currently, it likes what it sees over the long-term. Keep in mind that the stock market is made up of corporations and much of the trading on Wall Street is done with machines/algorithms and those computers are taking the emotions out of investing. Investors know that earnings are depressed and could snap back quickly once local governments and consumers feel comfortable to be in public spaces again. There is also something to be said for corporate management preparing for market chaos back in early 2020 when the pandemic initially began. They had an idea of what was going to take place with the pandemic and made decisions based on those convictions.
So, we now know the market is looking forward and likes what it sees, but are investors too exuberant? Is the stock market overvalued at these levels? One of the first measures I look at is the S&P 500 forward price-to-earnings ratio. The forward P/E consists of a corporation’s earnings estimate for the next 12 months. These estimates for all 500 companies are then added together and then divided into the current S&P 500 price. Thus, the larger the numerator and the smaller the denominator, the more expensive the stock market. According to the Wall Street Journal, the forward price-to-earnings (P/E) ratio for the S&P 500 as of January 15, 2021 is about 24.15. That is high whether you compare it to last year or the historical average of about 15. In recent weeks it has been as high or higher than the P/E ratio during the euphoria of the dotcom days of the late 1990’s and early 2000’s. Thus, by this measure the stock market seems expensive.
But then, you must take a step back and ask if the corporate earning estimates are too low and, in fact, will be much higher should consumers begin spending again. Moreover, the forecasted earnings may have been quite conservative given that many corporate leaders did not want any surprises coming out of COVID-19. If consumers feel more comfortable traveling or going to movies sooner (obviously, this depends on the effectiveness of the COVID vaccines), you could see the earnings increase. If the stock market stays at current pricing levels, the forward P/E ratio could decline quickly and stocks could look reasonable again. As I have mentioned many a time before: It is all about earnings, earnings, earnings. If XYZ corporate earnings slide permanently, that individual stock will struggle. On the other hand, if corporate earnings increase, that stock will look more appealing. When those individual stocks are taken as a whole, we have the overall stock market.
At this point let us take a brief look at how our portfolios performed in 2020. Depending upon your portfolio’s size, most of you will own the securities mentioned below.
Fixed Income: In the second week of March last year, we were seeing atypical price swings within our bond funds. That was scary and I continue to believe if not for the Federal Reserve stepping in and dropping the discount rate to 0.00-0.25% and buying tons of bonds during this perilous week, the bond market and the stock market would have gone down much, much more than they had. The Fed formed the bottom in both markets and bonds and stocks have been up ever since. I took the liberty to purchase higher quality bonds during this time as we did not know how long the drop was going to take. I held these higher quality bonds through the end of the year. Incidentally, for many of you I established a position in the Vanguard Core Bond Admiral. This fund uses managers at Vanguard to overweight areas that are inexpensive and underweight areas that are considered expensive. They perform these services for 0.10% or about one-quarter the fee that PIMCO or Metropolitan West would charge. The bottom line? Our short-term fixed income returned low single digits while our intermediate-term bonds were mid to high single digits in 2020.
Large-Cap Domestic Equities: As we know Facebook, Amazon, Apple, Netflix, Google (now called Alphabet) and Microsoft (FAANG-M) stocks helped support the S&P 500 and the total stock market index in the first nine months of the year. The PRIMECAP funds (Vanguard PRIMECAP Core, PRIMECAP Odyssey Growth, PRIMECAP Odyssey Stock), Vanguard Dividend Growth and Berkshire Hathaway all underperformed the index for the year due to not owning FAANG-M stocks. Yet, as I write this, the three PRIMECAP funds mentioned above are all in the top 4% of funds within their category in the first two weeks of 2021. That recovery was needed and I will be paying particular attention to Berkshire Hathaway this year as it trailed the index by a wide margin in 2020.
Mid and Small-Cap Equities: We saw a huge resurgence in the mid and small-cap space over the past three months and into the new year. Perhaps diversifying outside of FAANG-M will payoff in 2021?
Foreign Equities: At some point our foreign stock holdings will outperform our US stock holdings. I just don’t know when that will be. Since November, Oakmark International has begun to outperform their index. In fact, Oakmark International is in the top 1% of their category. That said, both First Eagle and Oakmark underperformed their indices in 2020. Should “value” investing come around this year, these funds will do well.
Outlook: The fourth quarter was a better quarter for the non-FAANG-M names. Some of our value and “growth at a reasonable price” holdings climbed more than the index during this time. Many investors are favoring small-cap and value stocks as the new presidential administration will most likely favor more stimulus and less tariffs which will favor these types of companies. If you think some of the indexes hitting all-time highs will place a ceiling on returns in 2021, think again. Several analysts that I follow believe the Fed committing to 0% interest rates for the next two years will be a boost for stocks in the near-term. Ed Yardeni believes the S&P 500 could hit 4,300 by the end of 2021 and 4,800 by the end of 2022. The S&P 500 is currently at around 3,800 – that is a 26% return by the end of 2022.
I have some exciting news: My co-worker Nicole recently passed her series 65 – Uniform Investment Adviser Law Exam and is now a Registered Investment Adviser Representative of American Investment Advisors! A big congratulations to her as this exam is not easy. Please do not hesitate to contact either of us with any of your investment questions. We are here to serve you!
As you know, we never take your loyalty to American Investment Advisors, Inc. for granted. Thank you for your support over this past year and best wishes for a HEALTHY 2021! Enclosed you will find your Portfolio Holdings statement as of December 31, Performance Analysis and Position Performance summaries and a quarterly Account Management Fee Statement. Please contact us should you desire the most recent copy of our Form ADV Part 2A. In addition, please notify us should your investment objectives or personal financial situation change.