Despite a massive “second wave” of COVID-19 cases in the 4th quarter, the stock market finished the year at an all-time high as vaccines began to be distributed globally.

Value/Dividend stocks outpaced Growth stocks in the 4th quarter, possibly signaling a shift in investor behavior as they look forward to a post-COVID recovery.

We expect the US to record its highest debt-to-GDP ratio of all time by the end of 2021, even higher than in the aftermath of World War II or the Financial Crisis. This has stoked new inflationary fears which could eventually lead to higher interest rates and higher taxes.

With Biden’s victory and Democrats narrowly controlling both the House and Senate, investors anticipate significant additional fiscal stimulus and public investment in 2021.

2020 will forever stand-out as one of the most memorable years of our lives; a year marked by a deadly pandemic, a brutal recession, a politically divided nation and one of the steepest bear markets in history. However, there were also many positives during the year. We embraced technology to stay close and connected to work colleagues, family and friends but were reminded to never take for granted those family gatherings or dinners with friends.

We also saw increased acts of kindness, helping our community and a rise in pet adoptions. Finally, the medical advancements which led to the fastest development of a vaccine in human history should have lasting positive impacts and could lead to other scientific breakthroughs. With 2020 now safely in our rearview mirror, we have several reasons to be optimistic in the new year. But as experienced investors we know optimism rarely translates to predictable behavior.

Looking back at the fourth quarter

Every so often an invention, or in this case, a pandemic, comes along and drives change at such velocity that investors can almost feel the ground shift beneath their feet. Last year COVID forced businesses and consumers to prioritize and expand digital/remote operations. The stay-at-home era has been a boon for e-commerce, cloud computing, digital payments processors, video streaming and home improvement stores. Meanwhile, for travel, food service, brick-and-mortar retail, and live entertainment, 2020 was literally the worst of times.

After plunging 34% from peak to trough in the first quarter, the market staged a remarkable comeback over the remainder of 2020. Thanks in part to a reduction of political uncertainly and clarity on the rollout of COVID vaccines, the S&P 500 ended up 11.7% for the quarter and 16.3% for the year. For the first time in 7 quarters, Value/Dividend stocks outpaced Growth stocks, possibly signaling a shift in investor behavior as they look forward to a post-COVID recovery.

Still, for the year Growth outpaced Value by over 30%, one of the widest spreads since the dotcom bubble. Pandemic “darlings” such as Amazon, Zoom, and Home Depot all trailed the broader market significantly in the final quarter. Meanwhile sectors that had been the hardest hit over the first 3 quarters such as Travel and Energy outpaced the market by double digits. Small-cap and foreign stocks, which had also been laggards, substantially outpaced large-cap U.S. stocks to finish the year firmly in positive territory.

Bonds had a solid quarter as the aggregate and municipal indexes both rose 1% and finished up 7% and 4% on the year respectively.

Looking forward to 2021 and beyond

The key question for 2021 is how much of the seismic shift in consumer and business activity was purely COVID driven, and how much will persist in the years ahead? It is safe to say the post-pandemic economy will look very different than the one we had in February 2020. It is going to be more efficient and more dynamic, and there will be winners and losers.

Our job as investors is to identify companies that have the potential to generate solid growth in a post-pandemic world, whether by continuing to benefit from these trends, or by benefiting from pent-up demand in certain goods and services such as travel and entertainment. We expect to see strong GDP growth in 2021 and unemployment should continue to fall, but there is often a delay between job destruction and job creation.

Outlook for U.S. Equities

Rapidly changing consumer behavior will continue to drive opportunity for digital leaders across industries. But not all experiences can be digitized. Pent-up demand is poised to drive opportunities in travel, energy, and other hard-hit sectors. Our base case is a continued uneven recovery centered on the assumption our economy will be mostly reopened in the second half of 2021. We believe stock prices of big tech mostly reflect the shift in consumer behavior, and therefore we expect laggards from 2020 to continue to lead in 2021 as they did in the 4th quarter.

Opportunity in International Markets

Asian and European companies are among the world leaders in some key innovations such as digital payments and renewable energy. Remember, investing is about companies, not countries. Additionally, the growth of the middle class in emerging market countries (China, Brazil, etc.) is an ongoing phenomenon where substantial opportunities still exist. It is likely a historically strong U.S. dollar will continue to weaken, which would help boost returns in foreign investments.

Alternative assets can help you diversify

We continue to view alternatives as an important component of portfolio construction for their diversification. Much like the overall market, the pandemic created winners and losers in the world of real estate investments trusts (REITs). Some hard-hit sectors like hotels and retail should see a rebound in coming years while data centers, industrials and others that did well in 2020 should continue to see positive momentum. Additionally, we believe the natural resources and commodities that we added to our portfolios last summer will benefit from increased demand and a stronger economy.

Checking in on Fixed Income

Although interest rates will likely remain at ultralow levels, high quality bonds remain a crucial buffer against volatility. We also continue to look to research-driven bond funds for their ability to uncover key opportunities and higher yields.

We believe now more than ever a portion of your fixed income should be invested in funds who can be flexible and look outside of the more traditional fixed income investments. Higher yields generally mean taking on more risk (credit, duration, etc.) so we are looking for the appropriate balance.

What about Inflation

Massive government spending across the globe suggests stronger growth in the near term and eventually higher inflation. We expect the US to record its highest debt-to-GDP ratio of all time by the end of 2021, even higher than in the aftermath of World War II or the Financial Crisis. Previous episodes of rising inflation were costly for investors, leading to higher interest rates that pressured valuations across asset classes. Yet central banks have indicated they will be more willing to let economies run hot with above target inflation. Therefore, the conversation about inflation is likely one for 2023 or beyond. In the meantime, low inflation implies continued low interest rates which traditionally have buoyed riskier assets such as stocks.

A New Political Landscape

We understand you may be either thrilled or demoralized by the “Blue Wave” hitting Washington. But as we have written many times before, it is not wise to make investment choices or financial decisions based on political outcomes. Rather, it is best to focus on your own personal financial plan and what is knowable and likely to occur.

With Democratic control of the Legislative and Executive branches of government, we expect to see additional large-scale fiscal stimulus and a renewed interest in public investment, both of which are likely to give a much-needed boost to the economy. Additionally, we anticipate a more traditional U.S. approach to trade, foreign affairs and working with allies.

There is also reason to anticipate bipartisan compromise on a variety of issues given the closeness of the elections and the narrow majority currently held by the Democrats. Tax increases on the wealthy and corporations remain possibilities, but the timing and severity are unknown and unlikely to be the main driver of stocks in 2021.

Bottom line

As we reflect on a tumultuous year, we are most thankful that our families, clients, and co-workers are healthy and safe. We feel very fortunate that we have been able to continue to work (remotely) on your behalf throughout the pandemic. We know there are many who are not as fortunate. While we certainly miss seeing many of you in person and the camaraderie of working side-by-side in our office, we are hopeful that we will (mostly) return to business as usual before the end of 2021. Therefore, we approach the new year with a sense of optimism, and we thank you for allowing us to guide you through these unprecedented times.