2021: Vaccine Versus Virus
To say that 2020 was an unusual year would be an understatement. We experienced a global pandemic that caused a rapid worldwide economic recession. In the United States, the service sector was especially hard hit due to social distancing and self-quarantining containment strategies. Many people suddenly became unemployed and entire industries were decimated by lack of demand or forced reductions in services. Monetary support from ultra-low interest rates, combined with government stimulus programs, turned the tide and prevented the recession from morphing into a prolonged depression. For the year, economic output is estimated to have contracted 3.5% with corporate earnings declining by 15%. Surprisingly, stocks staged a 68% rally from their late-March bottom and the S&P 500 rose 16% for all of 2020. What should we expect during 2021?
Clearly, the foremost issue for the New Year will be taming Covid-19. Multiple vaccines against the virus have been tested and approved in record time, with possibly more on the way. For numerous logistical reasons, the rollout of these vaccines to the general public has been suboptimal and ramping much more slowly than planned. Additional strains of the virus which are even more transmissible have recently emerged. There also remain a number of unknowns for the vaccines, including the degree and length of protection against the virus and its various mutations. While defeating the pandemic will not occur quickly, new virus infections have declined substantially from the peak in January. From an economic perspective, generating growth will be more challenging early in the year as the virus headwinds take time to abate.
The majority of monthly economic indicators have shown remarkable V-shaped rebounds from their lows last spring. However, some of them began to stall at year-end. To sustain forward momentum amid the mounting challenges from the pandemic, the economy requires additional stimulus. President Biden has therefore proposed a large $1.9 trillion “American Rescue Plan” which includes direct payments to households, an expansion of jobless benefits, funds for state and local governments and expanded vaccination and virus-testing programs. This follows on the heels of a $900 billion relief package passed in December. Biden is also expected to propose an even larger economic plan focused on infrastructure and long-term job creation.
This immense amount of government spending has in the aggregate offset the reduced income from job losses. Household savings totaled $3.9 trillion in January, up from $1.4 trillion last February, prior to the pandemic. This enormous amount of money sitting in savings has contributed to the U.S. money supply increasing by 26% versus the prior year–the largest percentage increase since records began over 60 years ago! That makes for a great deal of pent-up demand and potential future spending that will eventually act as an economic tailwind later this year.
At the same time that the money supply swelled so much, the Federal Reserve has vowed to keep interest rates at extremely low levels. The Fed Chairman has even gone so far as to state that rates won’t be raised until there is “troubling inflation” and policy will not be tightened to ward off inflation threats, as has historically occurred. Inflation will trend higher this year, especially when measured against the weak environment last year, but not to problematic levels. With very low interest rates and money market fund assets that have ballooned by over 19% to $4.8 trillion during 2020, some of that money will certainly look for the higher potential returns of equities, creating incremental demand and exerting upward pressure on stock prices.
In summary, a waning pandemic with continued economic growth and low interest rates should translate to higher stock prices. American adults could be fully inoculated as soon as the end of May. The current headwinds from the virus will likely be negated by incremental government spending. Portfolios filled with the types of companies we own generating strong growth in revenues, earnings and/or cash flows should continue to appreciate in value this year. We look forward to the strong potential for additional gains from the economic and political environment that we currently envision.
Holger Berndt, CFA
Director of Research
hberndt@rssic.com
