Fourth Quarter Market Review
John Fischer, CFA®, CFP® | Chief Investment Officer
January 19, 2021
The experience of investing often feels much like a roller coaster ride. With both, you get the feeling of flying up peaks and plunging into valleys.
With amusement park rides, however, we can usually judge whether or not a particular coaster is something we can handle before we get in line. Investors, on the other hand, often struggle to choose an investment strategy and portfolio allocation that suits their tolerance for thrills, twists, and turns.
As a result, many investors end up with a mismatch in their ability to handle risk and what kind of ride their portfolio takes them on. Those that make it through to the end of the ride aren’t necessarily better at choosing between specific investments. Instead, it’s more likely that they were simply better at choosing a portfolio that matched their comfort with risk and volatility.
I always feel the roller coaster analogy is a good one for describing the investment experience, but 2020 highlighted that even more so than most years do. We saw significant disruption of daily life, pain and suffering on many fronts, and massive change forced at almost every level — from the individual to societal, and from private businesses to public institutions.
Here’s a closer look back at the year no one saw coming, and the lessons that investors can gleam from such a topsy-turvy twelve months.
Heading Up the Lift Hill of 2020
At the beginning of 2020, it seemed that the stock market would continue its upward trajectory into the new year. The market marched higher through January 2020 and hit a new high on February 19th. Unemployment sat at a 50-year low and the economic backdrop looked solid.
If the market really was a roller coaster, then this was the climb up the lift hill. The first drop was the COVID-19 pandemic, officially declared as such in mid-February. That pushed both the market and the economy itself over the hill to plunge into a steep decline. By March, the S&P 500 registered stunning losses of 34%, setting a record for the fastest-developing bear market in history.
How the Economy Reacted to the Blow
As the pandemic dragged the global economy down in the spring, the massive, coordinated response of monetary and fiscal stimulus put a halt to the market’s precipitous decline. Congress passed the $2.2 trillion CARES Act in late March, bringing financial relief to consumers, businesses, and state and local governments.
It was the largest fiscal stimulus package in the country’s history, representing more than 10% of annual U.S. GDP. The Federal Reserve also dropped their key interest rate to 0%, reintroduced bond buying programs, and opened new credit facilities to support the economy.
The stock market began to find its footing in April. The economy, however, continued its free fall as unemployment soared to 14.7%, its highest level since the Great Depression. The forced economic shutdown put GDP on its own roller coaster that seemed divorced from financial markets.
Even as stock prices stabilized and started to look less apocalyptic, the economy suffered the worst quarterly decline on record in the second quarter, declining 31%. Although things looked grim, GDP came roaring back in record fashion with the subsequent economic reopening. The economy notched its highest quarterly growth in history in the third quarter, with GDP gaining 33%.
Markets Take Us on the Most Extreme Ride Yet
Interest rates weren’t exempt from a whiplash-inducing drop and rebound. Investors flocked to the safety of bonds in March as stocks plummeted in value. Meanwhile, the Fed cut interest rates in an effort to support the flailing economy. 10-year treasury bonds began the year yielding 1.80%, but as a result of the pandemic and the response to it, fell to a historically low yield of 0.32% in early March as the Fed cut rates and fearful investors piled out of stocks and into bonds.
Still, it wasn’t all bad news in the market. The S&P 500 regained all of its losses for the year by late summer. It was the fastest return from a bear market we’ve ever seen. Historically, the market needed 6 years to hit new highs after downturns on the magnitude we saw in March.1 But this time? The market needed just 126 trading days before setting new record highs in August.
The S&P 500 closed out the year in stunning fashion, posting an annual gain of 16% despite being forced to navigate the challenges of rising COVID cases and one of the most polarizing presidential elections in history.
Lessons from 2020’s Thrill Rides
The chaos and unpredictability of 2020 set innumerable economic and stock market records. But it also reinforced some time-tested investing principles that are worth remembering:
- Don’t focus on short-term market movements. The short-term can be misleading, and long-term investors know better than to track every daily or weekly market movement along the way. Had you looked at the S&P 500 on March 23rd, you would have seen losses of 30% for the year. But if you only looked at market performance once or twice a year, perhaps you checked on July 1st instead — and you would have seen S&P 500 losses of just 3%. Reviewing your portfolio less frequently can help keep your focus where it needs to be: on the long-term.
- Don’t sleep on the value of bonds. Despite yields beginning 2020 near historically low levels, investors were reminded of the importance of bonds in their portfolio when the S&P 500 fell by 34% in February and March. During that same period, the Barclays Aggregate Bond Index was down only 1%, outperforming stocks by a whopping 33%. Owning bonds provides benefits when it comes to diversifying and managing risk.
- The stock market and the economy are not one in the same. In the first quarter, the stock market plunged despite 3.5% unemployment, rising wages, and modest GDP growth. In the second quarter, the stock market soared despite seeing some of the worst economic data in decades. The stock market is forward-looking while economic data is mostly backward-looking in nature.
- Stay the course over time. We all have a bias towards action. As investors, this action bias can lead us to bad outcomes for our long-term goals. Had you considered moving to cash in the depths of the stock market decline in March or leading up to the uncertainty of the presidential elections, you would have missed out on sizable gains that are critical to your long-term goals.
- Beware of predictions and expect the unexpected. When 2020 began, no one predicted we’d be dealing with a global pandemic. No one assumed we’d see the 10-year treasury yield at 0.32%. No investors would have believed the S&P 500 would drop over 30% only to hit a new high just months later and finish the year up 16%. None of us know precisely what the market will do next (or what will serve as the catalyst for upward momentum or downward spirals). What we can expect is the unexpected, and we can plan for it by setting an investment strategy that is appropriate for our time horizon, appetite for risk, and specific financial goals.
The year 2020 sent investors on a wild roller coaster ride. We were all forced to navigate a new normal in the middle of a global pandemic with twists and turns that covered a range of struggles and unfortunate events.
As investors turn the page on 2020 and focus their attention towards 2021, most feel optimistic about the distribution of the COVID vaccine and with it, the potential to return to normal life. Even as we look to happier times ahead, here’s hoping investors won’t forget the invaluable lessons that such an unpredictable year provided us.
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