2021 investment outlook

Market news | Published: Dec. 15, 2020

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

Global economy

Quick take: We expect the global economic recovery will continue well into 2021, with the timing and uptake of a COVID-19 vaccine the key variable. Inflation pressures are likely to build early in the year before flattening in the back half. Emerging Asian economies, such as China, are likely to remain in the lead for much of 2021, due to their more limited COVID-19 infections at the close of 2020.

Our view: The COVID-19 vaccine will encourage the global recovery in 2021, with distribution and uptake of the vaccine key growth variables. Additional fiscal stimulus and an easing in trade tension may lift growth as well. The recovery will lift inflation, before softening in the back half of the year. The path of monetary and fiscal stimulus in the economic recovery are important factor for inflation.

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    • The global economy remains in recovery mode as we enter 2021. The effectiveness of limiting COVID-19 infection growth is the primary differentiator for pace of the recovery across global markets, though most all economies continue with limitations on certain activities.
    • Most global central banks are maintaining low borrowing rates to stimulate economic activity. Asset purchases from the Federal Reserve (Fed), European Central Bank and Bank of Japan also continue to support financial markets and economic activity. Such policies, coupled with continued and new fiscal stimulus measures, should accelerate economic activity into mid-2021.
    • U.S. economic activity likely flattened at the end of 2020 due to a pause in reopening to combat rising COVID-19 infections, hospitalizations and deaths. Reopening the economy and distributing a vaccine should support much stronger growth into the middle of 2021, after which the recovery should moderate, especially compared to the robust recovery in the second half of 2020. Stimulus measures, a strong housing market and recent increases in commodity prices should lift inflation, as well.
    • Emerging Asian economies including China, Korea and Taiwan should be leaders to start the year, with recoveries in Europe and Japan timed to the distribution of a COVID-19 vaccine. Absolute levels of growth will remain modest, reflecting demographic headwinds that remain a major factor for these economies.

U.S. equity markets

Quick take: Domestic equities rallied to all-time highs in the fourth quarter of 2020 on the heels of COVID-19 vaccine progress and ramping expectations for additional government stimulus. As we begin the new year, we expect volatility to be more the norm rather than the exception, swayed by the tug-of-war between COVID-19 vaccine optimism and evolving election-related clarity versus virus case growth and renewed activity and mobility restrictions slowing economic reopening.

Our view: We are maintaining our “glass half-full” orientation. Benign inflation and low-interest rates, supportive monetary and fiscal policy and COVID-19 medical progress support our positive outlook.

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    • 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.

Foreign markets

Quick take: China, South Korea and Taiwan, earliest hit by the COVID-19 pandemic and the economies earliest to reopen, led strong emerging market gains in 2020, narrowing the performance gap to U.S. equities. After posting relatively modest returns in 2020, foreign developed equities hold catch-up potential in a post-vaccine 2021 recovery due to relatively large weightings in sectors historically sensitive to the economic cycle, such as Financials, Industrials and Materials.

Our view: Economic momentum, China’s ongoing reopening and vaccine progress are positive catalysts supporting our balanced emerging market equity outlook. While we maintain a strategic bias toward U.S. equities over time, we also must respect foreign developed equities’ return potential in a post-vaccine, economic reopening scenario.

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    • 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.

Bond markets

Quick take: Corporate and municipal bond performance remains strong as investors begin to look ahead to a post-vaccine world. Interest rates remain low but have risen somewhat as growth and inflation expectations strengthened. Central banks will hold interest rates low and continue asset purchases while investors await additional fiscal stimulus.

Our view: We continue to see opportunities in corporate and municipal bonds. Incremental yield compared to Treasuries has fallen somewhat below normal historical levels, but we anticipate yields relative to Treasuries will continue to compress, driving corporate and municipal outperformance over Treasuries. Riskier high yield corporate bonds present compelling current income, but we favor normal allocations due to better return opportunities in equities.

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    • 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.

Real assets

Quick take: Utilities and Real Estate, two sectors closely tied to interest rates, were mostly flat in the fourth quarter of 2020 as the market started to look for better growth opportunities. Large shifts in work arrangements and living preferences reduced the ability of landlords to raise rents in many markets, providing a further headwind to real estate investments. An improving economy should be a tailwind for commodity prices and commodity producers in 2021.

Our view: The market continues to look beyond a potential near-term slowdown toward a recovery in future growth resulting from a COVID-19 vaccine. As the economy expands and inflation expectations increase in 2021, we believe commodities and commodity producers can benefit. Energy sector equities, including midstream infrastructure, and miners of industrial metals could also do well in this environment. Higher interest rates are likely to moderate the performance of Utilities and broad Real Estate sectors.

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    • 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

Quick take: With election results coming into clearer focus and multiple COVID-19 vaccines expected to be available in early 2021, hedge fund managers’ focus will return to analyzing company fundamentals and assessing which companies/sectors will perform best in the current and coming economic cycles.

Our view: The Technology and Healthcare sectors will continue to play prominent roles in our lives and present hedge fund managers with attractive investment opportunities due to the ever-changing dynamics within each sector.

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    • 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.

Private markets

Quick take: Private market investment managers took advantage of investors’ unrelenting appetite for initial public offerings (IPOs), exiting high-growth businesses in 2020. Maximizing returns of private investments through optimal exit pathways, such as IPOs, is just one tool in private market investors’ active management toolkit. Private debt borrowers’ widely anticipated defaults did not materialize in 2020, partly due to the flexibility of private lenders and widespread availability of cheap financing as the COVID 19 pandemic brought global economies to a halt.

Our view: Investor appetite for IPOs, the availability of cheap debt financing and opportunities to add value through activities such as consolidating businesses within fragmented industries continue to favor private market investments. Ongoing industry digitalization and healthcare innovation will present private market investors with unique investment opportunities in 2021.

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    • 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.

This commentary was prepared December 2020 and represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are not intended to be a forecast of future events or guarantee of future results and is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank or U.S. Bancorp Investments in any way.

U.S. Bank, and representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation. Diversification and asset allocation do not guarantee returns or protect against losses. Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.

Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer’s ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund. Private capital investment funds are speculative and involve a higher degree of risk. These investments usually involve a substantially more complicated set of investment strategies than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales, which can magnify potential losses or gains. Always refer to a Fund’s most current offering documents for a more thorough discussion of risks and other specific characteristics associated with investing in private capital and impact investment funds. Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable. The valuation procedures for these holdings are often subjective in nature. Private debt investments may be either direct or indirect and are subject to significant risks, including the possibility of default, limited liquidity and the infrequent availability of independent credit ratings for private companies.

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