At a glance
The global economic recovery will likely continue through 2021, bolstering risky assets. Key factors include the distribution of a COVID-19 vaccine and U.S. fiscal policies to complement continued low-interest rate and asset purchase policies by global central banks.
As we close out an event-filled year with considerable volatility and a 24/7 news cycle, investors are hoping that 2021 follows 2020 in numerical sequence, but not in event intensity. Two major events bookended 2020: A global pandemic’s onset in the first quarter and a major election in the fourth quarter. As you will read in our outlook comments, those two events will continue to be the major market drivers for 2021, with medical progress to halt COVID-19 the most important factor.
As we contemplate how global economies and the three core constituencies (consumers, businesses, and governments) who comprise them react to eventual reopening thanks to antiviral campaigns, we maintain a glass-half-full perspective on how diversified portfolios will perform in the new year. To be sure, events will occur not covered or contemplated, and capital markets will likely follow their usual non-linear paths. But the common thread in our individual section updates below is anticipating a gradual and durable global economic recovery that provides a favorable investing backdrop for long-term, diversified investors.
As always, we are privileged to have your trust, and we welcome any questions or follow-up you may have with respect to your unique financial situation. We wish you the best in the New Year and thank you for the opportunity to serve you.
― Eric Freedman, Chief Investment Officer, U.S. Bank Wealth Management
U.S. equity markets
- The fundamental backdrop remains supportive for equities. Along with an improving economy, benign inflation and low-interest rates provide valuation support. Inflation is currently higher than 10- and 30-year Treasury bond yields, meaning real interest rates, or interest rates less the rate of inflation, are negative. This increases the value of companies’ future cash flows.
- Valuations are elevated yet short of extremes. Rising analysts’ earnings projections provide valuation support. Consensus S&P 500 earnings expectations for 2021 are approximately $170 per share, which equates to a price-to-earnings ratio (price per share divided by estimated earnings per share) of roughly 22, a level we consider to be elevated yet below extremes.
- Information Technology has become the new defensive sector. COVID-19 has accelerated the need for 24/7 connectivity, mobility and all things internet. We see these trends continuing in the new year and beyond, supporting the notion that Information Technology and related industry groups have become the new defensive sector ― one that consistently delivers stable and predictable earnings both in good and bad times.
- E-commerce is gaining in popularity, driven by the internet’s convenience, reliability and contactless nature. We believe online sales usage and growth will remain high even beyond COVID-19. Consumers have come to appreciate online sales and same-day pick-up, drive-up and delivery services. We consider best-in-class operators to be those with an internet presence that also promote in-store traffic and a personal touch.
- U.S. equities’ dividend profile remains compelling. Equities remain an attractive alternative for investors looking for income. Approximately 70 percent of S&P 500 companies offer dividend yields (the expected dividend per share divided by the current price per share) above the U.S. 10-year Treasury note yield as of late-December.
- The fundamental backdrop remains generally positive for foreign equities. Central banks remained committed to accommodative monetary policy support. Restrained inflation and low-interest rates provide valuation support, meaning investors value equities’ future cash flows favorably relative to lower-yielding fixed income alternatives.
- Trade risks are set to recede, though other domestic and foreign policy risks for foreign equities could materialize. While policy observers expect a presumptive Biden Administration will be less confrontational with China and traditional European allies on trade issues, recent U.S. executive orders and Chinese regulators’ capital markets activity highlight the edgeless nature of domestic and foreign policy.
- Ongoing dollar weakness continues to benefit U.S. investors in foreign equities in two ways. First, it decreases the dollar-denominated costs for borrowers, supporting their domestic growth prospects and aiding corporate profitability. Second, a falling dollar increases U.S. investors’ foreign holdings values.
- Analysts are forecasting a strong foreign markets revenue and profits recovery in 2021. High forecasted earnings growth relative to sales reflects high operating leverage in foreign markets. In an economic recession, earnings contract more sharply than sales, while earnings’ rebound during an economic recovery is commensurately greater than the recovery in sales.
- Foreign equities’ valuation, or the price investors are willing to pay for anticipated earnings, is elevated relative to history. While continued vaccine progress provides optimism for a 2021 profits recovery, high valuation implies that investors are already pricing in positive future outcomes, and the potential for disappointment remains high.
- Treasury bond yields have begun rising but should remain low by historical comparisons. We anticipate the Fed will keep its policy rate near zero through 2022 and may expand its asset purchase program. Rising growth and inflation expectations may push longer-term bond yields somewhat higher, but rates are unlikely to return near historical averages any time soon. Treasury bonds provide important portfolio diversification, but low and rising yields indicate there are better opportunities elsewhere to enhance yield and performance.
- We see opportunities in corporate bonds. Large companies have raised a record amount of debt this year at the cheapest rates on record. Low corporate defaults rates in recent months provide evidence that high cash balances resulting from debt issuance are boosting companies’ ability to weather short-term pandemic-related challenges. Corporate bond yields compared to Treasury yields have fallen, and will likely fall further, leading to continued outperformance relative to Treasuries.
- Municipal bonds provide a valuable source of non-taxable income. Improving sales and income tax revenue forecasts and near-term expense management flexibility paired with improving investor expectations should drive strong municipal bond performance. We anticipate this trend will continue until incremental tax-equivalent yields fall closer to historical lows. Until then, we favor incurring slightly more credit risk than normal to generate extra income and favorable return potential versus Treasuries.
- Residential mortgage bonds not backed by the government remain attractive. Yields are high relative to other bond sectors, while fundamentals remain strong. Many homeowners in forbearance never stopped making mortgage payments, while those coming out of forbearance are performing better than anticipated. Current loans falling 30 days or more past due have reached pre-COVID levels, indicating low-interest rates, high borrower equity and a robust housing market are encouraging borrowers to remain current on their loans.
- An economic expansion, declining U.S. dollar relative to foreign currencies and increasing inflation expectations are a favorable backdrop for commodities, and prices for agricultural products, industrial metals and energy should move higher. Commodity producers appear to be the primary beneficiaries of these trends among real assets. The benefits of precious metals as safe havens are likely to subside further in 2021.
- Excess capacity exists in retail properties and in office and multi-family properties in the urban core. It will be hard for landlords to increase rents in these property types. Revenue and earnings are likely to disappoint. Dividend cuts and suspensions among real estate investment trusts are over for the most part, but we also don’t expect them to increase much in 2021.
- Work from home arrangements may become permanent for many employees. Additionally, an exodus of inhabitants out of many major cities appears to be underway. These two shifts are negatively affecting the office and apartment market in the urban core of most large cities.
- Crude oil prices were volatile in 2020 and rebounded in the fourth quarter but may be poised for a breakout. However, demand concerns still exist. The major producers need to keep forward supply balanced with potential demand for the crude market to return to health. Energy sector equities should benefit from a continued economic expansion.
Hedge fund strategies
- Technology companies can change the status quo in areas such as e-commerce, machine learning, cloud computing and cybersecurity applications. The ongoing digital transformation will drive new investment opportunities as different technology applications create companies focused on “smart” cars, homes, cities and everything within the internet-of-things.
- Healthcare companies are in a strong position to benefit from aging populations in developed countries such as the U.S., Europe and Japan and from developing countries’ rising middle-class spending on healthcare items, procedures, devices and pharmaceuticals. Demographics trends present opportunities for biotech companies involved with new medical devices, accelerated drug discoveries and researching cures for debilitating diseases.
- Healthy IPO markets and the proliferation of special purpose acquisition companies (SPACs) create a favorable environment for privately held companies to go public with the intention of maximizing returns for investors.
- As global economies continue to improve in 2021, private equity investment managers with operational expertise will shift focus toward revenue growth strategies. As revenues grow, cost rationalization activities implemented during the challenged economic environment of 2020 should lead to high-profit margins, ultimately resulting in strong investment returns.
- Accelerated healthcare innovation continues to show promise, as displayed by the unprecedented speed of COVID 19 vaccine development, accomplished in just nine months. Digitalization is spreading across industries at a feverish pace as businesses strive to attract the digital consumer and realize efficiencies. These trends are ripe for private market investment opportunities into 2021.