Hello, everyone, and welcome. Returns were strong across the board in the fourth quarter, concluding a full year of returns that would have been unthinkable back in March of last year. However, as we all know, returns had very little to do with the underlying growth picture.
Rather, the path of returns in 2020 reflected the markets’ changing views on the critical question: Will the fiscal and monetary bridge be long enough and strong enough to get to the other side of the virus?
Market strength after the programs were first announced gave way to questions about ongoing fiscal stimulus, which, in turn, was replaced by vaccine Mondays, where the likelihood of widespread vaccine distribution not only rose meaningfully but brought the expected finish line significantly closer, which, in turn, lessened markets’ fears about the size of the fiscal package that would be needed going forward.
Now we can see the result of those debt-driven market gains reflected in the overall debt growth and the ratios of household-net-worth to GDP and debt-to-GDP.
As a result, equity valuations, ex-the tech bubble and measured by the Shiller Cape, are at 140-year highs as we enter the year.
And after two years of declines in 2019 and 2020, yields, both nominal and real, are at or near historic lows. Translation: Expected 60-40 returns have fallen meaningfully over the past two years, and that creates significant future challenges for investors.
So how should an investor navigate this year? For starters, I believe that 2021 will be made up of two chapters: The first will run from now until, what I think of as, one day after the virus. The second will follow it and last for quite some time. In the first, investment opportunities are solid. There's still a great deal of uncertainty in the market as it relates to COVID, and where there's uncertainty, there's a potential for returns across a broad set of risk assets. And at a high level, allocating across those investments, in our opinion, is largely in line with the so-called rotation trade or, as I think of it, the eventual return to normal trade. However, rather than rush from one side of the allocation boat to the other, I'd suggest that investors consider approaching it from the standpoint of just a thoughtful rebalancing.
The second chapter for us is largely back to the future – a reboot of all the things we were talking about leading into 2020. The challenge: Returns will require portfolio construction with an eye toward downside mitigation, except that returns pulled forward into 2020 suggests the 60-40 returns we now expect over the next decade are a percent lower, and given declines in yields, earning income above the level of inflation has become even more difficult.
Fortunately, the toolkit is the same as it was a year ago. Ingredients that historically have offered good relative upside-to-downside participation, such as quality, with a focus on companies with strong balance sheets, persistent growth and free cash flow generation.
And for income, the credit barbell does as well, something we've spoken of many times before, blending high grade and high yield, with an eye toward opportunities in the emerging markets and securitized credit spaces to increase return potential.
As we make our way into 2021, I'd like to finish by saying that I very, very much wish all of you and your families a very happy and healthy 2021, and I look forward to a day when we have moved toward the other side of this and I'll be able to share these outlooks with many of you in person once again. Thanks, as always.