Review: Fourth Quarter 2020
What a Difference a Quarter Makes
To say that 2020 was an unusual year is to put it mildly. On March 23rd, the stock markets were at a low and a Bear market had been established (prices falling 20% or more).1 As noted in the Third Quarter Review, the markets had recovered much of their losses but, of the indexes we tend to follow, only the S&P 500 was up. The Dow was down, mid-cap was down, small cap was down and international was down. Then, along came the fourth quarter. As I had noted in the last newsletter the markets do not like uncertainty. After the election, the equity markets stabilized and began looking to the year ahead and measuring potential earnings.
Since investors look at potential results for periods of six months or longer, what might investors be considering currently? With two vaccines available that should fight COVID-19, we see the potential of a return to relative normalcy. This could mean lower unemployment and greater consumer spending. Capital spending might go up as companies, who have delayed spending, begin to spend, so they can grow. The treasury and President Elect have indicated that more stimulus money will be available. This can have a two-prong effect: more jobs, more spending. The tech innovations that changed our lives in 2020 will be geared more toward individuals and create new businesses. Current businesses, such as the auto industry, will make big investments in green technology. On the international front, many of the same things that are playing out in the U.S. are happening worldwide. With this as a backdrop, there is anticipation that earnings will grow, the political environment will be stable and equity investments will grow in value.
On the negative side, the spending by the government may increase the likelihood of inflation as well as the need to raise taxes. As technology has been soaring the regulators are taking a closer look at regulating and taxing aspects of these businesses, especially the very large players. This could have a negative impact on tech earnings. With increased growth and inflation, the interest rates on bonds and mortgages may be headed up.
Weighing the negatives and positives, at least for now, the positive outlook appears more likely in the near future.
Looking at the S&P 500
The S&P 500 appears to be overweighted with large tech stocks. Because of this, during 2020 when large tech was outperforming the general stock market, the S&P did significantly better than an index of large stocks, such as the Dow Jones Industrial Average (Dow), or the Russell 1000. At the end of December, the S&P 500 added Tesla to the average. 1 This is a very high capitalization tech stock that just reached four quarters of profit in the latter part of the year. It appears this adds more weighting to the tech sector. This is a problem because if tech takes a serious tumble, as it did in the year 2000, it could result in a major drop of the S&P 500. For a long time, I’ve used the S&P 500 index in my analysis.
The S&P 500 ended the year at 3756, up 18.4% for the year and up 11.7% for the quarter. The Dow, by comparison, ended the year at 30,606 up 7.2% for the year and 9.9% for the quarter. The S&P Mid Cap index closed at 2315, up 11.8% for the year and 21.6% for the quarter. The S&P Small Cap index closed at 1125 up 9.6% for the year and up 25.8% for the quarter. 1 As you can see, the mid cap and small cap stocks had a major upturn in the final quarter of the year after lagging during the first three quarters.
As stock prices rose the change in yield on bonds varied. The 10-year Treasury Note rose from 0.48%, at the end of the third quarter, to 0.913% at the end of the fourth quarter. 2 This increase resulted in a loss of value for the period. The Bloomberg Barclays US Aggregate Bond Index dropped, from 1.17% at the end of the third quarter to 1.12% at year end. The interest rate went up from 6.98% to 7.51%.2
The unemployment situation continued to improve during the fourth quarter dropping to 6.7%, based on the US Bureau of Labor Statistics, from 7.9% at the end of the third quarter. 2 Hopefully, this trend will continue.
The fourth quarter of 2020 was a very positive one for equities. These gains had a positive impact on most diversified portfolios. At a time when Covid-19 is spiking, it presents short term uncertainty to the markets. As the vaccine becomes more widespread it will hopefully have a dampening impact on the virus. Couple this with Federal stimulus, commitments by businesses to capital spending and a downturn in unemployment, we could see a good year for the market.