ECONOMIC OUTLOOK REPORT – 1Q-2021
Dreher Investment Services, Inc.
January 19, 2021
A Quick Review of 4Q-2020 Markets
Financial markets rallied to close the year at all-time highs, with the S&P Index posting a +11.69% return for the 4th Quarter and a +16.26% return for the year. Markets are trading forward on a combination of the optimism of a post-pandemic situation and the expectation that any future unstable fundamental economic conditions will be offset by the robust fiscal and monetary support seen in 2020. In the 4th Quarter, the Fed left the federal funds rate at 0.00% to 0.25%, reemphasizing their willingness to use prolonged low interest rates to combat the economic wounds generated by the pandemic. The 10-Year U.S. T-Note traded between 0.69% and 0.98% during the quarter, closing the year at 0.93%.
Many factors will determine the potential for a full recovery to pre-pandemic conditions, including: Covid-19 vaccine effectiveness and streamlining of distribution, continuation of the high level of fiscal and monetary support and the rebound of small businesses required to boost much-needed employment.
1Q-2021 Economic Outlook
From a fundamental standpoint, the U.S. economy has started its recovery, as illustrated below:
- U.S. GDP – GDP for 3Q-20 made a solid comeback, increasing at a +33.1% rate (beating the consensus of +32.0%). Consumer spending increased by 40% after being the main contributor to the horrendous economic numbers seen in 2Q-20. Initial 4Q-20 GDP estimates show a continued recovery trend, with the Atlanta Fed’s estimate at +8.7%. With strong numbers in the 3rd quarter and high estimates for the 4th quarter, we could see GDP negate some of the 2nd quarter loss, which was the largest in modern times.
- Employment and Wage Growth – December reported the first drop in non-farm payrolls since April, decreasing -140,000 and shaking the consensus that employment was in a steady recovery. After upward revisions, October and November reported gains of +654,000 and +336,000. The unemployment rate is now at 6.68%, far from the sub 4% unemployment numbers seen in early 2020. Certain sectors such as leisure and hospitality are experiencing prolonged unemployment. Until we see recovery in all sectors, consumers will struggle to once again be the driving force of the economy.
- Corporate Earnings – Although negative, corporate financials are showing some signs of stabilization from the depths seen in 2Q20. S&P 500 companies reported final 3Q20 earnings of -6.5% on the back of a -0.9% decrease in revenues. Initial estimates for 4Q-20 show a continued trend of losses for companies with approximations of a -9.8% decrease in earnings with a -1.3% loss in revenues. Early 1Q21 estimates show earnings growth of approximately +16%. With the market writing-off 2020 and trading forward to 2021, some question whether the recovery will live up to these lofty expectations?
- Inflation – November CPI rose +0.2%, slightly higher than analyst expectations. Core CPI for the year was unchanged from last month at +1.6%. Rising energy prices along with increased travel for the holidays were able to offset the other consumer price components that were muted during the quarter and overall kept inflation restrained. Strong competition and widespread unemployment will likely keep inflation subdued throughout the new year.
Other relevant topics that bear scrutiny:
Covid-19 – Worldwide cases of Covid-19 are now well over 90 million, with the U.S. accounting for over 22 million. Daily new cases have continued to soar after the holiday season as many Americans appeared to travel, thus causing another outbreak. Lockdowns are under way once again as countries continue to fight against the resurgence of new cases. The CDC’s vaccine tracker shows that over 7 million Americans have received a vaccine, with just 22 million doses being distributed. The vaccine program has drastically lagged its original targets of over 100 million doses to be delivered by the end of 2020. Nonetheless, the vaccine will continue to be distributed around the globe and should be available to all by mid-to-late 2021.
Federal Reserve System – The Fed’s operations have been one of the bright spots in the response to the pandemic. The Fed’s prompt and strong actions kept the financial markets liquid and operating during very uncertain times. It created methods for direct lending to U.S. states, counties, cities, small and medium-sized businesses. All of these unprecedented actions helped stabilize the financial markets. In the longer term, the Fed will want to wean markets off of such extensive support but will likely not begin this process for several years.
Even with recent positive vaccine and treatment developments, the global pandemic and its unprecedented impact is unlikely to fade in the coming months. As such, the massive fiscal and monetary response in the U.S. and around the world will probably remain in place for the foreseeable future. Despite the FED’s best efforts to keep credit cheap and easily available, a substantial number of businesses, especially small businesses, have already failed or will not survive. One of the biggest unknows about the economy is just how bad the damage actually is.
STRATEGIC MARKET OUTLOOK
The U.S. equity markets set all-time highs multiple times during 4Q20, finishing the year considerably higher. Markets continue to climb, even with the continued political turmoil and a resurgence of COVID outbreaks across the globe. The FED has played, and will likely continue to play, a major role in providing support to the broader markets, encouraging investors to take on continued risk during this uncertain economic time. Volatility can be expected in the short-term and will continue to be used as buying opportunities to establish long-term positions.
U.S. fixed income levels closed the year significantly lower than where they started the year, with the U.S 10 Year Treasury finishing 1% lower. Interest rates can be expected to remain compressed until we are well into the next economic cycle. Due to current conditions, we will likely hold any current long-term positions and keep duration short on any additional fixed income purchases.