The understandable desire to put 2020 behind us unfortunately offers a less-defined transition into the new year when it comes to the economy and financial markets. While analysts and market watchers across the spectrum see glimmers of hope and express general optimism regarding the year ahead, much of the good stuff isn’t expected to kick in until some time in the second quarter or later.
“The first half of the year could be ugly, with more stress on small businesses, consumer defaults and COVID is not behind us yet,” said Gary Zimmerman, chief executive of MaxMyInterest.
“As we get into the second half and people start to come out of their cocoons, and as the vaccine becomes more widely distributed, we’ll start to see the results of pent-up demand,” he said.
It is never fair to peg broad market and economic outlooks to anything as specific as a new calendar year, but the transition to 2021 offers proximity to several significant factors likely to impact the way money is earned, invested and spent.
Along those lines, the most common references among financial advisers and market prognosticators when considering the next several months include the new presidential administration, the efficacy and adoption of COVID-19 vaccines, and the shifting of power in Washington to an increasingly progressive Democratic party.
First things first: With the Georgia runoff election last week confirming that Democrats will control both Houses of Congress in addition to the White House for at least the next two years, all eyes are now on the lookout for higher taxes and increased regulations across financial services.
But despite President-elect Joe Biden’s campaign rhetoric regarding higher taxes, there is a general sense and hope that he can maintain a moderate stance.
“There are still some more centric Democrats and Republicans, so that thin majority line one way or the other probably won’t lead to any dramatic policy changes,” said Charlie Ripley, senior investment strategist for Allianz Investment Management.
Jim McDonald, chief investment strategist at Northern Trust, said the financial markets wrapped up 2020 expecting a divided government, in which Republicans retained control of the Senate.
“With the Democrats winning both Georgia Senate seats, it means they will be able to pass tax legislation and spending through the reconciliation process, but they won’t be able to pass anything else,” he said. “They also may be constrained in the level of tax and spending increases achievable, as the majority will be razor-thin and Democratic senators and representatives from Republican states or districts will be averse to major tax hikes or spending programs.”
Paul Schatz, president of Heritage Capital, said the market was so convinced that the Republicans would retain control of the Senate that a win by the Democrats could be a “catalyst” for market disruption during the first quarter.
“You’re going to have a strong headwind in 2021 and 2022, assuming that corporate taxes go up, individual taxes on high earners go up, and capital gains taxes go up,” he said. “The tailwind to counter that will be another massive stimulus program early in 2021, but that’s a one-shot deal.”
Schatz expects the stimulus spending to “juice the economy” in the second half of the year. “But don’t forget that the stock market is already trading as if it is the second half of the year,” he noted.
Noah Hamman, CEO of AdvisorShares, said complete Democratic control in Washington should trigger “adjusted investor expectations over the next two to four years.”
“Higher taxes will have a negative impact, but the devil is in the details,” he said. “If it’s just a blind repeal of the Trump tax cuts, that will be bad. Hopefully, we can find a balance, but that’s a lot to count on from politicians who don’t always keep their promises.”
Eric Beiley, executive managing director at Steward Partners Global Advisory, also believes the win by the Democrats in Georgia will disrupt the markets, agreeing with other analysts that the markets were fully anticipating the Republicans would maintain Senate control.
“The markets could step back, anticipating more substantial changes to the tax code,” he said.
Regarding the initial stock market rally last week when it became clear that the Democrats would win the Senate, Beiley gave a nod toward the power of market momentum.
“It clearly shows the current strength of investor sentiment in the stock market,” he said. “The strong market conditions that ended 2020 appear to continue in 2021 despite the political environment and the potential for higher tax rates.”
The election in Georgia was such an issue for the financial markets because of the outcome of the November presidential election that put Biden in the White House, along with his many promises to raise taxes and support government spending.
“Biden has signaled they would like to eliminate the Trump tax cuts,” said Ed Cofrancesco, chief executive of International Assets Advisory.
But in addition to Democrats’ holding the smallest House majority in history, Cofrancesco believes the more moderate Democrats will be able to keep the extreme left in check.
“By putting Janet Yellen in charge of the Treasury, I think they’re signaling they are not supporting an ultra-left socialist agenda,” he added.
Steve Skancke, chief economic adviser at Keel Point, also believes the slim margins in Congress will prevent Biden from accomplishing many of his more radical tax proposals that would rattle financial markets.
“Picking up both Georgia Senate seats gives the Democrats the advantage in managing the agenda of the Senate, confirming executive and judicial appointees and enacting moderate, consensus legislation” he said. “But in terms of passing anything that’s going to be radically different, there are enough moderate Democrats to make that unlikely.
“There will be a perception that things will change but the probability of big increases in corporate taxes, which are high on Biden’s agenda, are very unlikely as the economy is still in rebound mode. Additional fiscal stimulus and a bigger infrastructure spending package financed with more borrowing will be the biggest differences,” Skancke said.
Then there’s COVID-19 and the optimistic but sluggish rollout of the vaccines that began in late December.
“When it comes to investing, we normally talk about risk on and risk off, but now we’re talking about COVID on and COVID off,” said Sébastien Page, head of global multi-asset strategies at T. Rowe Price.
“The vaccine news is a significant positive surprise,” he added, before referencing the way the financial markets have seemingly become disconnected from the realities of a global pandemic.
“Even with unemployment still more than double what it was before the pandemic, stocks are closer to fair priced than most people think,” Page said.
The point is that even with all the negative impacts of pandemic-induced lockdowns and business shutdowns, the relative strength of the equity markets is simply the result of money finding the rivers being carved by government stimulus efforts, including the Federal Reserve’s monetary policies.
“The market is a cash-flow discounting machine, and during COVID rates went down by 100 basis points; that alone could justify a higher [price-to-earnings] ratio,” Page said. “If you think stocks are expensive, have you looked at bonds recently?”
Virtually across the board, prognosticators are betting on pent-up demand to drive the economy and the markets as soon as everyone gets the all-clear to get back to business and life in a newly vaccinated post-COVID world. But that could still be months away.
“We think GDP will rebound in the second half up to close to 4%, and inflation will move back toward the Fed’s target range,” said Ripley of Allianz.
He doesn’t see the Fed raising rates until at least 2023 and expects the 10-year Treasury yield to be around 1.25% at the end of 2021.
Ripley anticipates an “above-average return” for the S&P 500, adding that “close to 10% is not out of the cards.”
“A lot of this is hinged on the effectiveness around the vaccine,” he said. “There’s room for the markets to continue to rise from here. It’s a rebound in earnings that have been depressed from the COVID environment.”
Another factor supporting the pent-up demand theory is the bulked-up savings that were a byproduct of reduced spending in 2020.
While a lot of people lost their jobs as a result of the pandemic, those who were able to keep working realized a boost in real disposable income, according to Saumen Chattopadhyay, chief investment officer at Carson Group.
“We are sitting on pretty strong economic conditions because people didn’t shop or travel, so they saved money,” he said. “Pent-up demand is pretty strong, and you can see that in the housing market, where young buyers are the largest cohort.”
According to Chattopadhyay’s analysis, among working Americans, disposable income per capita is up nearly 6% from a year ago.
“The last time we saw it that high was 1984,” he said. “We probably have a pretty strong year ahead of us. I would not be surprised if the S&P finished over 4,500,” which is a gain of more than 20% from the end of 2020.
In terms of economic drivers, Chattopadhyay anticipates “almost immediate” passage of new $1,400 stimulus checks, expanded unemployment benefits, and more money for state and local governments.
“There is likely to be a continuous series of fiscal cliffs over the next two years, including debt ceiling increases that will be required in the summer,” he said.
Chattopadhyay said the medium-term impact of Democratic control will likely include an increased focus on climate policy, health care policy, immigration and anti-trust enforcement focused on technology firms.
“At the same time, due to a narrow Senate majority, there will be a very low probability of tax increases,” he added.
Eddy Augsten, managing director at Concurrent Advisors, cites the vaccine, an accommodative Federal Reserve, and a polarized government as reasons to be bullish in the year ahead.
“Expect life to accelerate in 2021,” he said. “The pandemic has created an excellent stock-picking environment and I expect active will outperform passive.”
Like most market watchers right now, Augsten points to the fixed-income market as an understated driver of stock market performance.
“Real rates are still highly negative and that has historically been good for equities,” he said.
Cofrancesco of International Assets Advisory is singing the same tune about skimpy bond yields giving investors no choice but to load up on stocks.
“Fixed income has to be in very short-term investments right now because there is no yield,” he said, adding that investors and advisers should be prepared for the next logical step on the economic road map: inflation.
“By 2022 we’re going to see inflation from all this, and we don’t know how the industry will deal with it, because most people in this industry have never seen inflation,” Cofrancesco said.
Schatz of Heritage Capital is also already looking past what appears to be a rosy 2021 to the threat of inflation further down the road.
“The inflation genie is out of the bottle,” he said. “We do need a little inflation, but the 2020s are going to be about old-fashioned food inflation that all the real people will feel. If wages don’t go up and you’ve got food inflation, that’s less money to go elsewhere, but that’s a mid-2020s story.”
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