The final three months of 2020 capped a tumultuous year for global financial markets, as nearly all investment categories posted strong results for a third-straight quarter.  In the U.S., large-company stocks advanced more than 10%, while small-caps surged to gains exceeding 30%.  Overseas, emerging-market equities edged out their developed-market counterparts; both categories rose more than 15%.  Real-estate securities also added around 15%, paced by non-U.S. and timber-related issues.  Industrial commodity prices leapt by double digits, paced by a 20% gain in crude oil; gold, however, was essentially flat.  Benchmark bond yields were modestly higher: the 10-year Treasury finished at 0.92%, compared with 0.68% at the end of September; credit spreads narrowed, resulting in solidly positive total returns from most credit instruments.

Among U.S. large-company stocks, those in economy-sensitive sectors led: Basic Materials, Consumer Discretionary, Energy and Financial Services were strongest; consistent-growth categories like Consumer Staples, Health Care and Utilities – along with Technology, on average – were relative laggards.  Continuing a pattern dating from September, ‘value’ stocks soundly outpaced the ‘growth’ variety within both large- and small-company universes.


Two-thousand twenty will enter history as a harrowing year likely to influence forever those who lived through it – perhaps unlike any since the Great Depression and Second World War.  Our comments this quarter rightly focus on the pandemic and its economic and financial-market impacts, though we remain mindful of other market-moving developments: from Russian cyber-espionage and worsening U.S./China tensions to global climate change and burgeoning agitation against ‘Big Tech.’  And, of course, seemingly never-ending political drama.

COVID-19 has been an unmitigated global disaster, especially cruel in its disproportionate impact on the aged, physically infirm, and socio-economically disadvantaged.  By yearend, documented infections (representing an unknown fraction of the actual total) were rapidly approaching 100 million worldwide, while deaths were nearing 2 million; the U.S. accounted for a disproportionate share of each statistic.  Although the Upper Midwest saw improving public-health trends after Thanksgiving, hospitalizations and deaths were near all-time highs at the national level entering the New Year, as the as-yet unquantified threat of a more transmissible virus variant loomed.

The pandemic and associated lockdowns – along with the instinct to curtail many normal activities in the face of fear and uncertainty – pushed the global economy into one of the deepest recessions on record.  As hundreds of millions across the globe abruptly found themselves unable or prohibited to work, second-quarter (April-June) aggregate output (GDP) shrank at unheard-of annual rates exceeding 30% in many countries.  Eased restrictions and marginally less fear of venturing out resulted in equally dramatic rebounds in the July-September period; the yet-to-be-reported fourth quarter will be notably slower in the face of renewed virus surges and lockdowns.  Though uneven (see next paragraph), the recovery has on balance been more ‘v-shaped’ than was widely feared in the pandemic’s early days.  Recent projections of the total decline in output – as well as estimates of time needed for full recovery – are markedly better than those made mid-year.  Still, when all is accounted, the global economy will likely have shrunk by around 4% – dwarfing the -0.1% dip spawned by the 2008-2009 Global Financial Crisis (GFC).

Though the calamity spared no one, different regions and economic sectors experienced divergent impacts.  While the U.S., Europe and Japan (along with major emerging markets Brazil, India and South Africa, as well as Russia) experienced deep contractions that will take two or more years to recover from, China and several other East Asian nations were dramatically more successful suppressing the virus and limiting economic damage; China is expected to be the only large nation to record positive economic growth for the full year.  Likewise, the manufacturing and industrial sectors rebounded more quickly – and have been more resilient in the face of renewed infection waves – than most service industries; and providers of ‘work from home’ solutions like Amazon and Zoom Video have flourished while restaurants, theaters, travel/tourism and most traditional ‘bricks and mortar’ retail have been decimated.

Economic devastation – and financial-market performance – would have been immeasurably worse if not for rapid and massive macroeconomic policy responses across the globe.  The U.S. Federal Reserve immediately cut overnight interest rates to near zero, greatly expanded its purchases of a wide range of financial instruments, and rolled out a slew of unprecedented direct-lending programs.  Meanwhile, the initial U.S. fiscal package exceeded $2 trillion dollars – nearly three times the size of the 2009 GFC ‘bailout.’  Likewise, the European Central Bank expanded asset purchases and new ultra-cheap loans for the region’s banks, while the European Union agreed to its first-ever issuance of collective debt as part of a 750-billion-euro ‘solidarity fund.’  According to the International Monetary Fund, global fiscal measures enacted in response to the pandemic have exceeded $11 trillion, while central banks have provided nearly $8 trillion of incremental liquidity via asset purchases and direct lending.

As Oarsman clients know well, financial markets – having notched new all-time highs in mid-February – reacted belatedly but violently to the pandemic.  The S&P 500’s 34% plunge between February 20 and March 23 was among the steepest on record; safe-haven government bond yields sank to all-time lows; credit spread blow-outs caused double-digit ‘mark-to-market’ losses on non-government bonds; and global energy markets were roiled by a vicious Saudi-Russian price war that briefly sent the price of crude oil far below zero.  This confluence of market disasters made the middle two weeks of March especially unnerving.  But as the parameters of the public-health emergency and, more importantly, the unprecedented magnitude of government responses came into focus, a broad-based rally was ignited.  As detailed in the chart below, all major asset categories joined a new bull market, which saw major equity benchmarks recording gains of 20%+ in the second quarter followed by nearly 10% in the third; the ‘everything rally’ gained new momentum in early November with the passing of the U.S. elections and, more important, the announcement of unexpectedly hopeful vaccine trial results.

The post-March 23 stock-market rally was characterized by a tug of war between competing views of the future – ‘Work From Home’ (WFH) versus ‘Return to Normal’ (RTN) – driven by the ebb and flow of public-health and economic news.  The stocks of companies seen as WFH beneficiaries – high-growth technology/media leaders like Alphabet, Apple and Microsoft; Consumer Staples brands like Kimberly Clark and Campbell’s Soup; ‘essential’ retailers Walmart, Target and (of course) Amazon – were ascendant for most of the second and third quarters.  But their RTN counterparts – beaten down industrials; travel and leisure providers; second-tier retailers; banks – gained a firm upper hand in the fourth.  The day the first vaccine trial results were announced (November 9; coincidentally also the first trading day after the presidential election results were ‘called’ by mainstream media outlets) saw the biggest-ever one-day ‘style’ rotation, with large-cap value stocks, as a group, besting growth by a whopping 4.8 percentage points.  Fourth-quarter performance was dominated by value, small-company and emerging-market equities – all seen as among the biggest beneficiaries of an accelerating, ‘reopening’ global economy.

The economic carnage caused by the pandemic wreaked havoc with aggregate corporate profits.  While earnings reported during the October-December period were down just 5% from a year earlier – and came in better than analyst expectations – the tally for all of 2020 will likely show a decline approaching 25%.  Though Wall Street analysts typically enter each New Year too bullish, 2021 could be an exception, as last year’s aggressive spending discipline creates substantial earnings leverage as sales rebound; still, the +38% gain currently penciled in may prove ambitious.

What’s Changed?

To provide insight regarding recent stock market performance, we can deconstruct the three-month return from stocks into three components:

1)         Dividend Income (for three months this is the annual yield divided by four)

2)         +/- Change in Earnings per Share* (average for S&P 500 companies)

3)         +/- Change in Valuation (Price/Earnings Ratio)

= Total Return

                * based on forecast earnings for next 12 months (Source: S&P Outlook)

So, what changed during the recent quarter to produce the +12.2% S&P 500 total return?

Fourth Quarter (October – December) 2020
Dividend Income +0.5% +12.2%
+ Change in Earnings +8.3%
+ Change in Valuation +3.4%
= Total Return +12.2%

Our read: The improved outlook for year-ahead earnings is salutary and likely to persist in coming quarters; valuation is high, but should recede as profits ‘catch up’ to prices.


As we look ahead to 2021, though setbacks and disappointments are inevitable, public-health and economic developments promise to be mostly salutary, boosted by the gathering momentum of worldwide vaccine rollouts.  Investors nevertheless face multiple worries, including long-term economic ‘scarring,’ a surprise inflation spike or policy error, stretched valuations and elevated investor complacency.

Beyond an inevitable winter slow-down caused by the resurgent virus, the economic and corporate outlook is clearly brightening.  Renewed lockdowns and natural risk aversion will likely begin to suppress infections in coming weeks, while over the next several months highly effective vaccines should reach a substantial fraction of rich-world populations.  As the oppressive restraint of the virus lifts, the underlying economy is poised to benefit from a range of positive forces: extremely low interest rates; consumer finances buttressed by elevated asset values and forced savings; pent-up consumer-spending and business-investment demand; inventory restocking; rising wages; the prospect of increased infrastructure and/or green-energy spending.  Accordingly, the IMF projects global GDP will expand in 2021 at its fastest pace in 45 years, with the U.S., Eurozone, Japan and China all expected to record above-average growth.  Against this backdrop, strong corporate-earnings gains seem all but assured, with economy-sensitive industries posting the biggest increases.  So, what’s not to like?  As so often, the list of concerns is not short.

First, the pandemic recovery is worryingly ‘k-shaped’ – that is, a relatively rosy average outlook masks a bifurcated reality that is distinctly better for some workers, industries and political entities than it is for others – which may handicap growth for years to come.  The better-than-expected decline in headline U.S. unemployment (which has dropped below 7% from nearly 15% in April) masks a growing number of displaced workers the Labor Department deems ‘permanently unemployed.’  Many of these, whose ranks are now larger than at the peak of the Global Financial Crisis, will suffer permanent erosion of skills and productive potential.  The corporate sphere is likewise populated by ‘haves’ and ‘have-nots.’  According to The Economist, ten mega-cap technology/media firms expanded their collective capital expenditures by 3% during 2020, while 1000 less fortuitously positioned firms slashed investment by more than 80%. This pattern can be expected to worsen already worrisome industry concentration, declining competition and stagnating innovation.  A further legacy of the pandemic is elevated debt.  According to S&P Global, total global debt grew by more than $19 trillion during 2020, reaching percentages of GDP not seen in many rich nations since the wake of the Second World War.  Though sovereign entities that issue debt in their own currencies accounted for more than 40% of the total, corporate borrowers possessing no such exorbitant privilege were right on their heels.  While near-zero interest rates will suppress debt-service costs for the foreseeable future, at some point a meaningful rise in corporate defaults and bankruptcies, along with counterproductive fiscal austerity and/or financial crises among public-sector issuers, seem all too likely.

Another risk is the potential for accommodative macroeconomic policies coupled with rebounding growth to ignite a burst of global inflation.  Most economists are relatively sanguine on this issue, as strong secular dis-inflationary trends underpin the price stability enjoyed in recent decades.  But it is surely plausible that an unexpected uptick in prices could result from a combination of shorter-term, cyclical factors: higher raw-material costs; production/distribution bottlenecks; newly raised minimum wages; exuberant post-vaccine spending.  And the Biden administration has signaled its view that substantial incremental spending is needed to support and broaden the economic recovery (‘build back better’).  Against this robust fiscal backdrop, Fed bankers have made clear they don’t expect even to begin thinking about raising interest rates for two years or more.  With long-term bond yields and market-implied inflation expectations only modestly above mid-year lows, investors do not seem well positioned for accelerating prices; earlier than expected monetary tightening (or even a clumsily executed change in Fed signaling) could readily prompt an unpleasant market reaction akin to 2013’s ‘taper tantrum.’

A most important question for investors eyeing the New Year is whether the late-2020 rotation favoring ‘value’ investments will persist.  Reasons to be hopeful include accelerating earnings growth, increasing pricing power, rising bond yields and a weakening dollar – all favor economy-sensitive, small-cap, and emerging-market stocks that tend to excel in the early stages of an economic cycle.  Moreover, as noted in past letters, the lengthy period of outperformance by large- and mega-cap growth stocks has resulted in a gaping valuation discrepancy that history suggests is likely to be followed eventually by a multiyear period of mean reversion during which previously laggard investment categories play catch-up.  Though a repeat of this pattern is not assured, we believe it is prudent to lean into the nascent trend.

A final, non-trivial concern is how much of the admittedly bright outlook is amply discounted by the strong financial-market performance of the past nine months.  Valuation is challenging, though probably not insurmountable: while the overall U.S. market is richly priced at around 22 times year-ahead earnings (compared to a more normal 15x or so), the average is inflated by index-topping mega-cap technology/media names (Alphabet, Amazon, Apple, Facebook, Microsoft; recently joined by Tesla) that change hands for between 30 and more than 100 times profits.  Large swaths of the market – comprising stocks across many industries – trade at eminently more sustainable valuations, especially when historically low bond yields are taken into account.  A broadly diversified portfolio can readily be constructed with a dividend yield around 3% – highly attractive compared to 10-year Treasuries anchored below 1%, and especially compelling when one considers the likelihood of dividend growth in a period of accelerating economic activity and, perhaps, rising inflation.  Less reassuring: investor sentiment – often a useful contrary indicator – has recently become notably more positive (complacent).  According to a December Bank of America survey, institutional investors have reduced cash buffers to their lowest since mid-2013 and are feeling the most ‘bullish’ since early 2011; similarly, the trading ratio of ‘put’ options (bets on falling prices) to ‘calls’ (bullish bets) has fallen to its lowest level since 2012.  These statistics argue for a degree of near-term caution.

In closing, we admit struggling with the appropriate tone for this letter and apologize if we failed to find it.  Contemplating jarring realities behind and unsettling uncertainties ahead, we were repeatedly reminded that 2021 – its early weeks, at least – will be a time when far too many grieve; when some are in bitter denial even as others are hopefully grateful; when all are extraordinarily weary.  And yet we were also heartened, if simultaneously somewhat chagrined, by the remarkable resilience of our investments, which showed again the wisdom of ‘staying the course’ – so long as the course be prudently plotted and faithfully followed.

As always, we encourage you to call or email us with questions and comments regarding our management of your investments.  And we wish you the happiest of New Years.

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