2020 was a challenging year for investors. But 2021 might be a challenge as well—for different reasons. Here’s a look at the opportunities and risks.
For seasoned market professionals and newbies alike, 2020 brought a crash course in pandemic investing. We were all pretty much learning on the fly how to invest during COVID-19. As 2021 unfolds, we know more than we did a year ago. A few investing themes for a pandemic recovery appear to be getting established. Yet many questions remain for investors. Specifically:
The rollout of the first COVID-19 vaccines in late 2020 was encouraging, but there’s still a ways to go, according to Viraj Desai, senior manager, portfolio construction at TD Ameritrade Investment Management, LLC.
“We’re learning to coexist with COVID as more and more people get vaccinated,” Desai said. “But just because we have a vaccine, that doesn’t mean we won’t be dealing with COVID for a while. COVID-19 is likely to continue to be a part of our lives for at least the next year. For long-term investors, basic principles of economics and portfolio strategy still apply.”
Where’s best to invest in 2021? Here are a few important considerations for investors in the year ahead.
As Desai pointed out, recessions are typically marked by weak equity market performance and stronger fixed-income performance. In a recovery, the opposite is true: Stock prices will climb as economic recovery expands and confidence returns to the market.
Yields on long-term Treasuries and certain other fixed-income assets crept higher during late 2020. Should the recovery continue, rates may rise further as the Federal Reserve takes a less-accommodating—or more “normalizing”—stance toward monetary policy. As demand for “safe-haven” assets like Treasuries recedes, bonds may be poised for underperformance (bond prices move in the opposite direction as rates) compared with historically riskier assets like stocks.
“If the recovery accelerates, raising corporate earnings growth prospects, investors may be looking for greater returns than what they’ve been getting in fixed income and, as a result, sell safer investments like Treasuries,” Desai explained. “All of these factors are headwinds for the fixed-income market in an economic recovery.”
Economic recoveries often spur investor “rotation” out of safe havens and in to riskier assets. This may produce opportunities in so-called “value” stocks, which tend to be geared more toward the path of the economy than their “growth” counterparts, Desai stated, citing historical evidence of value stocks outperforming other investing categories during recoveries. Other riskier categories, such as small-cap stocks and high-yield debt, could also be set up for outperformance.
In 2020, U.S. growth stocks raced ahead of many other categories. For example, as shown in figure 1, the S&P 500 Growth Index (SGX) had gained about 30% for the year, compared to a gain of 8.5% for the S&P Small Cap 600 ($SP600) and a decline of about 3% in the S&P Value Index (SVX) through late December.
Will such patterns shift the other way in 2021? The economy will likely have a big say (along with a few other investing themes for 2021).
“As more people get vaccinated by mid-2021, we may see material improvement in economic activity,” Desai explained. “But there are many risks that will prevail until then. One positive is that there’s pent-up demand for goods and services in our economy. As businesses reopen with more gusto, that could set us up for a transition to a recovery.”
With COVID-19 still sickening thousands daily and relatively few vaccinated, economic and market risks remain high in early 2021. But risk factors could subside over the course of the year as more people get inoculated.
How to tell if risk levels—or the market’s assessment of risk—are going up or down? “Treasury yields and the Cboe Volatility Index (VIX) are among indicators worth following,” Desai said. The VIX, the so-called fear gauge, was in 80-plus extremes last March.
The VIX, which reflects put and call options trading on the S&P 500 Index, often spikes higher briefly before quickly falling back. If it doesn’t do that, investors might want to take heed. “If VIX remains persistently high, that could signal something ominous for the market,” Desai noted. Similarly, a sharp drop in 10-year Treasury yields, for example, could signal heightened market concern.
Investors should also keep an eye on equity valuations, such as price-to-earnings (P/E) ratios and corporate earnings guidance. More companies issuing upbeat earnings forecasts and/or exceeding analysts’ earnings forecasts may bode well for the overall market. Conversely, if P/E ratios remain elevated but corporate earnings are not rising apace, that could be a signal of trouble.
Additionally, tracking broader economic indicators, such as employment and retail sales, can help validate whether recessionary conditions are indeed waning and a recovery is picking up steam.
As with any new year, the start of 2021 offers long-term investors a prime opportunity for a portfolio check-up and assessment of strategy and objectives.
“Part of this exercise involves taking a comprehensive look at your portfolio and making sure you’re not concentrated in any of the areas that could underperform” over the next 12 months and beyond, Desai explained. “If you’re more weighted in fixed income compared to stocks, for example, you may seek opportunities to diversify.”
Another critical item: Remember, past performance does not guarantee future results. Just because an investment did well in 2020 doesn’t mean you’ll get a repeat performance in 2021.
“If you invested in ‘COVID-insulated’ stocks, such as technology, you may have done very well in 2020,” Desai mentioned. “So, you could consider taking some profits and move some money into value stocks, setting up for a transition to value that may occur if the economic recovery gains momentum.”
Investors should also remain disciplined, revisit their expectations, and think about adjustments they may need to make depending on best-case, worst-case, and other types of scenarios.
“If something bad happens, such as a turn for the worse with COVID, you want to be prepared,” Desai suggested. “Don’t lose sight of your core diversification goals. If your investment thesis is wrong, you don’t want to find yourself blindsided. Part of the effort in working through recessions is making incremental changes. Make sure you’re exposed to the right investment themes for a recovery while maintaining diversification and slowly evolving your portfolio.”
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