Many of you have likely read several articles celebrating the end of 2020 and now are looking forward to 2021. Even the President of our firm, Pat Becker, in his blog last month asked for his dinner check early, wanting 2020 “to be over.” As investors though, we must take note of the past to help guide us into the future. It is therefore worthwhile to look back, however painful, at a year which we can all agree is one for the record books.
For me, 2020 could not have started on a more positive note. Our daughter, Katy, a junior at University of Washington, was studying abroad her Winter Term, spending six weeks in Paris and then six weeks in Rome. A perfect excuse for a family vacation! My wife Liz and I met her in Paris in early February for a couple of days and then took the opportunity to visit Florence and then Venice (Northern Italy ring a bell?) before meeting up with her again in Rome. As we departed Rome the third week of February, the S&P 500 was hitting a record high, yet news was beginning to surface that the COVID-19 virus had traveled outside of Wuhan, being detected in of all places, Northern Italy. After arriving home, we received a panicked call from Katy, worried about the spread of the virus and the likelihood she could be exposed. She wanted to come home immediately. As the ever-knowing father with all the answers, I told her to relax and enjoy her time abroad. It would not be an issue since she had not traveled to that part of Italy. Was I ever wrong!
As March unfolded, and with the virus continuing to spread, governments and other institutions across the world sprang into action. On March 11th, the World Health Organization declared COVID-19 a pandemic. On March 13th, President Trump declared COVID-19 a National Emergency and announced a travel ban on non-US Citizens traveling from Europe. On that same date, the NCAA announced the cancellation of their men’s basketball tournament (March Madness) and Augusta National postponed its annual tournament, the Masters, held each year in early April. Let us hope that March 13th will not be celebrated annually as “COVID-19 Day.”
Markets understandably took notice of the economic damage likely to be caused by this highly contagious virus and consequent lockdowns. Market volatility, as measured by the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, spiked to a March 18th intra-day high of 85.5, levels not seen since the 2008/2009 Great Financial Crisis (GFC). There was extreme disruption in the fixed income markets, even for U.S. Treasuries, the largest and most liquid market in the world. And the S&P 500 declined 34% in just 23 trading days, the fastest drop of this magnitude in market history.
So, must have been a terrible year, right? Well…no. By now it is well-known that major markets had positive returns for the year. The S&P 500 generated a total return of 18.4%, led by the mega-cap technology names which have dominated this index. The Dow Jones Industrial Average (DJIA) returned 9.7%, while international markets, as measured by the MSCI All-Country World Index (MSCI ACWI), were up 11.5% buoyed by a decline in the dollar, which fell 5.4% against a broad basket of other currencies for the year on rising inflation fears. Bonds produced positive returns for the year, helped by the sharp drop-in interest rates across the yield curve during the early stages of the pandemic. The Bloomberg Barclays Intermediate US Government/Credit Index was up 6.4% for the year.
How could markets rally against a backdrop of rising unemployment, contracting economic activity, and lower expected corporate earnings? Markets are inherently complex, and there is never one reason which can explain their moves. But here are three important events we think frame the resiliency of the markets in 2020:
1. Federal Reserve
The Fed was quick to dust off its playbook developed during the GFC and instead of taking a fire hose to douse the erupting flames, they applied a water cannon. First, they lowered the Federal Funds Rate (Funds Rate) on March 3, 2020 from 1.75% to 1.25%, and then less than two weeks later cut the Funds Rate to 25 basis points (0.25%). Less than a week after the first cut in the Funds Rate, they provided liquidity to the repurchase agreement market (the repo market), an important funding source for broker-dealers who provide the capital needed to keep our markets properly functioning. They also re initiated their bond purchase program (known as Quantitative Easing, or QE), providing additional funding to the credit markets. Why was this important? These actions provided liquidity to keep credit markets open and helped avoid a corporate solvency issue brought on by the sudden cessation of American business activity. In short, it bought time for corporate America to adjust and develop a game plan to address this economic threat.
2. Congress
Not usually known for easily reaching consensus on major legislative issues, in this instance Congress moved quickly. On March 27th President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act (CARES Act), a $2.2 trillion economic stimulus package, also the largest such package in U.S. history. Key provisions of the Act included expanded unemployment benefits, direct payments to most Americans, government loans and loan guarantees, and the Paycheck Protection Program (PPP). Combined with the Fed actions listed above, liquidity/cash was now flowing to both businesses and individuals, keeping the injured economy on life support.
3. Improving Underlying Economic/Market Fundamentals and Expectations for More
It is possible to debate the implications of Central Bank interference with the natural process of market-based price discovery and the longer-term issues of deficit-fueled fiscal spending. But at the end of the day, when we look back to the March lows, we have come a long way. The unemployment rate peaked at 14.8% in April 2020, after hitting a 50-year low of 3.5% at the end of 2019, and is now at 6.7% (still too high, but much improved). Gross Domestic Product (GDP), a broad measure of economic activity, contracted a previously unthinkable 31.4% for the second quarter of 2020, and then rebounded an equally remarkable 33.4% in the third quarter of the year. GDP is now expected to contract 5%-6% for 2020, again not ideal but much improved from the outlook earlier in the year. Finally, corporate earnings expectations for 2020, as measured by the S&P 500, increased 18% off the lows as the second half of the year unfolded after having been lowered 20% from the beginning of the year to early May. At the end of the day, markets and economies are intrinsically linked and with an improving forward economic outlook, markets responded accordingly.
My colleague T.J. McConville wrote earlier this year that while COVID-19 is a major disruptor to world economies, it is more importantly a human tragedy. As 2020 unfolded, I often reflected upon on my trip to Italy and the loving spirit of the Italian people, a culture that knows the importance of family and community. As we move into a new and more hopeful 2021, may we all strive to embrace the Italian spirit, slow down a little and appreciate the simpler things in life.
Pat, instead of asking for the dinner check, you should have stayed for your espresso!