Slowly but surely, we’re turning a corner on one of the most volatile years on record. From the challenges of Covid to social unrest, the markets and the economy reflected the uncertainty of the time that was 2020. Now that a new year is here and vaccine rollout is occurring in earnest, is there a possibility of finding financial optimism and getting back to what we knew as normal?
How Covid Affected the Economy
Prior to the pandemic, we were experiencing one of the strongest economies and unemployment was the lowest it had been for more than 50 years. Then Covid hit, and unemployment rates jumped to 14.7% in April 2020, its highest level since the Great Depression. Stock markets dropped quickly into one of the fastest bear markets we had ever seen. Real GDP also decreased globally over the year, including emerging markets.
However, as vaccines are being rolled out and demonstrating effectiveness, the economy and markets are responding positively - though it is likely to be somewhat of a slow build. While the markets dropped, we also experienced one of the fastest recoveries in history. This was largely due to the lowering of interest rates, which is something we’d seen throughout prior recessions. The difference in 2020 is that the Fed took almost immediate action to move rates to 0%, but Congress also passed measures such as the CARES Act and a second stimulus package in late December.
Disconnect between the Real-World Economy and the Stock Market
Though it may seem counterintuitive, some sectors benefited hugely from the pandemic. As more people worked from home, industries such as technology and retail saw their business earnings soar. Meanwhile, industries that required in-person gatherings, such as travel and hospitality, suffered.
Even though the stock market recovered, it’s important to remember that much of it is being financially engineered by the banking sector and the Federal Reserve. One consequence of this is that the forward price-to-earnings ratio is very high, and we haven’t seen these numbers since the tech bubble burst. However, we can’t say that this is a case of history repeating itself: Fed support is a lot more aggressive than it was back in 2000, and the economy itself has innovated and evolved from where it was even 20 years ago.
A Look Ahead
We anticipate that the Fed will continue to keep interest rates near zero until at least 2023. The Federal Reserve balance sheet was rather high pre-Covid, and though they attempted to reduce the balance sheet, the trade wars and pandemic didn’t help. By the end of the year, that balance is expected to sit at around $9 trillion.
Should Investors Keep Bonds?
Even though interest rates are as low as they are, we still advise keeping bonds in your portfolio. It’s generally true that bonds perform the best when interest rates decrease. Even so, when interest rates hold steady, bonds have a decent rate of return. Even as interest rates eventually rise, the rate of return on bonds has been shown to keep up with inflation. This means that the return may not be as large as you were anticipating, but it is still effective - especially as a means of diversification against the ups and downs of the stock market.
Steps You Can Take as An Investor to Find Financial Optimism in Changing Times
Given the ups and downs of the past year, it can be difficult to be optimistic as an investor. One of the ways you can safeguard against market highs and lows is to review your portfolio. Ask yourself whether you are still comfortable with your current level of risk and discuss possible changes with your financial advisor. As fiduciaries, our number one priority is to work in your best interest.
You also want to make sure that your portfolio is diversified enough. If you’re in retirement and your portfolio is mostly bonds, you want to make sure that they are giving you the returns you need to live comfortably. If not, then you need to talk with your financial advisor and consider adding stocks and other assets to the mix or make changes to the way you’re spending.
Remember, market volatility is normal and nothing to be afraid of. As you’re following the changes, it helps to have a team on your side so that during times of stress and uncertainty, you don’t have to make reactionary decisions alone. No matter your financial situation, we’re here to help.
The Team at Chatterton & Associates
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc., nor its registered representatives, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.