News & Media
Market Perspectives – Fourth Quarter, 2020
CitizensTrust – A Division of Citizens Business Bank
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Financial markets were strong in the fourth quarter as the presidential election uncertainty passed, the Fed and the government continued to support an economic recovery, and vaccines were approved in the fight against COVID-19.
U.S. stocks rose sharply in the fourth quarter with a 12.1% gain in the S&P 500, which increased the YTD gain to 18.4%. All of the major indices finished the year on a strong note, marking record-high levels during the last week of the year. In remarkably quick fashion, the 34% sell off, fueled by pandemic-related lockdowns last spring, transitioned to the strongest start to a bull market since World War II.
Throughout the year, equity performance had largely been powered by the technology sector. That trend continued in the fourth quarter as NASDAQ gained over 15%, taking the YTD gain to 45%. Lockdowns and restricted activity accelerated trends such as online shopping, working from home, and distance learning – all of which benefitted a variety of technology companies. It was the second year in a row that NASDAQ gained over 40%.
Something that was decidedly different in the fourth quarter was that the market broadened out and a wider variety of sectors and stocks began to outperform. In market parlance this is referred to as “strong breadth” and is typically a sign of a healthy market. This breadth drove mid and small-cap stocks significantly higher in the fourth quarter. Prior to this quarter, they had lagged the S&P 500 throughout the year. Mid-cap stocks, as measured by the Russell Mid-Cap ETF, were up 19.9% for the quarter. Small-cap stocks, as measured by the Russell 2000 Small-Cap ETF, were up 31.3%, which is one of the best quarters ever for small-cap stocks. This left the mid-cap index up 17% for the year and the small-cap index up 20%.
Outside the U.S., International Developed markets, as measured by the EFA ETF, were up 15.7% during the fourth quarter and 7.6% for the year. Emerging markets, as measured by the EEM ETF, were up 18.4% for the quarter and 17.0% for the year. Globally, the MSCI World Index rose 16.3% in the third quarter, finishing the year up 14.4%.
Interest rates remained stable in the fourth quarter. The Federal Reserve has made it clear that it will not raise interest rates until the economy recovers back to full employment levels and inflation is above their 2% target for an extended period of time. As a result, in contrast to recent years, interest rate volatility should be relatively subdued in the new year. Many of the Fed liquidity programs initiated in 2020 are scheduled to wind down in 2021 and the bond market will have that to focus on in the coming months. It will indeed be interesting to see if the Fed can smoothly break the addiction pattern of constant stimulus which prevailed in 2020.
The Fed did succeed in contracting credit spreads and steepening the yield curve over the past several months. The yield curve, the difference between the two year U.S. treasury and the ten year, continued to steepen throughout the second half of the year, signaling that the bond market expects better economic times ahead and the low interest rate environment to persist. Investment Grade credit spreads, which ended 2019 at a low 93 basis points, collapsed all the way back to 96 basis points by year end after one of the sharpest spikes ever in reaction to the economic collapse. This is another sign that investors are feeling good about offering credit, or at the very least they know the Fed will have their backs if things go awry.
Economic measures continued to recover in the fourth quarter; however, the entire global recovery appears to be challenged by a resurgence in COVID-19 cases. Most re-opening plans have been delayed or even halted as authorities attempt to do something meaningful towards the goal of slowing the spread. The vaccine rollout has begun and will accelerate in the coming months. This is good news and is fundamentally necessary for the anticipated strong economic growth of 2021 and 2022 to occur. The average estimate of U.S. GDP growth for 2021 and 2022 is currently 4% and 3.1% respectively. This is above recent trend line growth since the economy is recovering from an economic shock. The unemployment rate is expected to fall to 5.5% by the fourth quarter of 2021. All of the estimates mentioned above assume the virus wanes and the economy reopens reasonably soon. Another stimulus package was passed in December, but the support it will provide is relatively small and certainly less impactful than the CARES act. Additional fiscal aid may be necessary if restrictions persist beyond the first quarter.
The strong housing market has been a silver lining of the pandemic and has provided much-needed support for the economy. Existing Home Sales have surged well past pre-pandemic levels as being forced to spend more time at home has increased demand for more space. Supported by record-low mortgage rates, the positive home price, construction and related nesting trends that were jump-started by the COVID-19 crisis are likely to continue throughout the coming year.
The Quarter Ahead
We did not expect a global pandemic in 2020, but its rapid escalation into a financial crisis was not surprising given the response by local governments to lock down citizens and halt economic activity. Although recent trends related to COVID-19 remain negative and have impacted economic activity, the economy is still likely to make significant progress as the year progresses. Easy comparisons to awful 2020 numbers will allow for year-over-year growth. Many COVID-19 related trends introduced to us in 2020 will reverse in the coming quarters, and others are likely to linger for an extended period of time. The unintended consequences of COVID-19 and our reaction to it will present opportunities and impact companies in various ways, both good and bad, in the year ahead. For now, financial markets are looking ahead to a more normal second half of 2021 as vaccines become more widespread and herd immunity approaches.
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