Q1 2021 Economic & Market Outlook

Executive Summary

In a year that offered a pandemic and an election as reasons for investors to bail on risky assets, 2020 turned out to be a great year for those that stayed the course. A 60/40 portfolio of diversified stocks and bonds increased by a double-digit percentage, exceeding what would be expected on a historical basis even without a pandemic crippling the global economy.

Looking through the asset classes shown in Exhibit 1, one would be hard pressed to find “doom and gloom” in returns for the most recent quarter or the full year. Even real estate and commodities bounced back in the fourth quarter. Most dramatically—and most optimistically—small caps’ fourth-quarter performance catapulted them in front of large caps for the year taken as a whole.

Index List: Tax-Exempt Intermediate: ICE BofAML 2-12 US Muni Index, Taxable Intermediate: BBgBarc US Ag Intermediate Index, U.S. Large Cap: S&P 500 Index, U.S. Small Cap: Russell 2000 Index, U.S. Large Cap Growth: Russell 1000 Growth Index, U.s. Large Cap Value: Russell 1000 Value Index, Developed Markets: MSCI EAFE Index, Emerging Markets: MSCI Emerging Markets Index, Real Estate: FTSE NAREIT All Equity REIT Index, Commodities: Bloomberg Commodity Index, U.S. Dollar: U.S. Dollar Index.

Source: Morningstar Direct

As we look forward to 2021, we see a favorable backdrop for markets. We expect a synchronized recovery in the global economy, sales and earnings are expected to grow in all sectors and monetary and fiscal policy are expected to remain supportive. However, markets reflect a lot of this good news already, so returns in 2021 may not keep up with the improvement in the economy as prices tend to reflect future data with a six to nine-month lead time.

Looking longer term, investors are facing a challenging investment environment. Intermediate-term bonds are yielding about 1% and stocks trade at valuations that imply low to mid-single-digit annual returns over the next 10 years. As a result, investors are looking beyond the traditional 60/40 stock/bond portfolio to successfully meet their income and return goals.

Looking Beyond the Traditional 60/40 Portfolio

• Allocate to complementary investments as substitutes for bonds and/or stocks to manage risk and/or enhance returns.
• When the risk is justified, tactically allocate to non-traditional bond strategies such as high yield and emerging market bonds, which offer the opportunity for higher returns.
• Employ opportunistic portfolio rebalancing to capture gains in stocks when sentiment runs hot, so portfolios have the capacity to reinvest when pessimism returns.
• Stress-test estate plans and financial plans for the below-average returns that may occur over the next 10-15 years.

Economy

• While we expect a bumpy start given the high level of virus cases, consensus expects 4% real GDP growth in 2021. Upside of 6% may be possible with the recently passed stimulus package and a successful rollout of the vaccine.
• Problems with the vaccine rollout, dramatic changes in taxes or government regulation, and geopolitical turmoil are just a sample of issues that could impact the recovery.

Politics

• The immediate focus of the Biden administration will be on addressing the pandemic: the rollout of vaccines, nationwide mask policies, and additional assistance to aid the economic recovery.
• With Democratic control of all branches of government we can expect higher taxes, infrastructure spending focused on green initiatives and drug price regulation. However, the magnitude of change may be limited given a slim majority.

Equities

• We expect positive returns from stocks in 2021, but gains will not likely keep up with expected earnings growth, which has risen to 23%, as sentiment and prices have shifted from a cautious to an optimistic outlook.
• We expect the cyclical market leadership that started in the fourth quarter to continue into 2021. However, we do not expect the performance gap between sectors to be as wide as in 2020.
• While we have an overweight to cyclical sectors, we believe that it is important to stay diversified. A setback to the recovery could lead to a rapid change in leadership back to defensive or “stay at home” stocks.

Fixed Income

• Return expectations should be tempered as we expect interest rates and inflation to move higher in 2021. However, we expect no hikes from the Federal Reserve until late 2022 at the earliest.
• The positive economic backdrop favors corporate bonds and non-traditional fixed income investments like emerging market bonds.
• While yields are low, bonds still have a place in the portfolio as a ballast when risk markets decline.
  
  

ABOUT THE AUTHOR

Brian Andrew

Chief Investment Officer | Johnson Financial Group

As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.