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Investment Research Note – February 19th, 2021

This week marks one-year since stocks hit their pre-COVID highs.  In the twelve months since those highs, investors experienced a monumental period for the markets that ran the gamut from a crash with the peak of volatility to “face-ripping” rallies to such downright odd price movements in certain assets….that all you could do was shrug.   Even with all that 2020 threw at the markets, the economy and society, 2020 was, by all means, an above average calendar year for investors.  The S&P 500 was up 18.40% and with falling rates, the Bloomberg Barclays Aggregate Bond Index returned +7.51% for the year.1  However, we are left now to break down the aftermath of it all as we sit amid what feels like an early-cycle economic recovery and rejuvenation but also feels very late-cycle for investing characterized by elevated valuations and rising speculative activity. 

Final Readout On 2020

Broad markets produced strong returns, point to point, in 2020.  The gap between Growth and Value widened during the year and the US continued to outperform International.  The sector story was similar to the recent past: Tech stocks led, and Energy lagged.2 But in between the points, 2020 was a remarkable year and a year with many lessons and takeaways to pull from; these three resonate particularly loud and clear:

  1. The market is not the economy and “the market” is not necessarily the stocks you own

Stocks rallied as devastating economic data points rolled out including an unprecedented spike in unemployment.  The companies that make up the public markets had a unique ability to

weather this storm and were mostly insulated from Main Street economic peril. In many cases they were able to take advantage of their scale to gain even better competitive positioning.  The market has also shown itself to be extremely forward looking during this crisis – looking out past the exogenic shock of the pandemic to the full recovery.

For most of the year, mega-cap Tech stocks carried the water for the whole market.  For the year, the median stock in the S&P 500 returned +8.5% vs. +18.4% for the index because of the strength of the most heavily weighted holdings.  The Top 5 stocks in the S&P 500 as of 12/31/19 returned on average +53% during 2020.3

2. Don’t underestimate the Fed and its monetary policy tools

The Fed was not “out of ammo” as many had declared.   Even after dropping rates and ramping up Quantitative Easing, the Fed further stepped into the markets and unleashed policy measures to bail out the credit markets and reinstate investors’ confidence.  The stock market clearly took notice of the backstop.

3. The best days are typically clustered among the worst but its near impossible to time them

Hypothetically, a long-term equity investors’ returns are negatively impacted if they sit out the best days in the markets; that is a fairly obvious statement.  The issue is that the best days typically happen in close proximity to the worst days in the markets and trying to be out of the worst and back in for the best is not a feasible strategy. Although, there is no guarantee that an upswing will always immediately follow a downswing, historical returns benefit those who stay invested through the full market cycle.4,5

Volatility is the best condition to evaluate an investors’ process and principles and 2020 provided more than enough of those conditions.  The year set records and hit milestones and will go down in the books as one of the most notable in market history – to take lessons from the year is an important benefit for investors going forward.

Market Breadth

The market lacked breadth for much for most of 2020 – the largest companies were carrying the index.  However, breadth came back in a big way during the 4th quarter of 2020 and has continued into 2021; which is a positive development and breakthrough for the market as a whole to continue sustaining the upward trajectory of equities. 

This broadening out of the market performance can be observed by comparing the returns of the S&P 500 (market-cap weighted – largest companies are weighted the heaviest) vs. the S&P 500 Equal Weight Index (each company is weighted the same) as well as comparing large caps to the Russell 2000 Index (smaller sized companies):


Rotation is a term to describe the shift in outperformance amongst investment styles – for example from the Growth style to the Value style or from domestic US to Developed International and/or Emerging Markets listed companies. 

As is well known, the Growth style has been strongly in favor over recent years:

A major looming question for the market as 2021 moves along is whether there will be a change in leadership for the market from Growth to Value.  This prospective shift has been eagerly anticipated by Value investors, but Growth has continued to widen the gap in outperformance.

Without making a prediction at which style will ultimately win in the short-term, at the very least a rebalancing opportunity is available to investors to rebalance out of the Growth strength and into the Value weakness to balance their equity portfolios.

The other major rotation that may be afoot is from US to International equities.  The US outperformance vs. foreign issues has been of even greater magnitude over the past ten years: 

So far in 2021, Emerging Markets are performing strongly; through 2/17/2021 the MSCI Emerging Markets Index is up +12.03%.  Developed markets are also positive but more in line with the US, the MSCI EAFE index is up +4.08% year to date through 2/17/2021.7

Valuations and Earnings

Given the market’s rise in 2020 and the substantial drop in earnings catalyzed by the pandemic, valuations have expanded to an elevated level.  4th Quarter earnings are still trickling in but are mostly accounted for and S&P 500 companies are on pace to post -11.4% in negative earnings growth for all of 2020.  This places the P/E ratio on the S&P 500 at 22.2x vs. a 5-year average of 17.7x and a 10-year average of 15.8x, which make valuations on the market undoubtedly rich relative to history.8

The good news is earnings are estimated to grow by +23.6% during 2021.9 There’s opportunity for the market to grow into its multiple if the pace of earnings exceeds the collective companies’ price appreciation during the year.  2020 was a wash year for earnings releases – the market seemingly gave companies a ‘pass’ as they printed really bad results.  2021 is a statement year for earnings releases with a high bar already set in the analyst community.  Companies will need to produce on the top and bottom lines during the expected economic boom or else the current lofty multiple may not be warranted.


2020 Real GDP is projected to contract -3.5% from 2019 – this is the first calendar year contraction since 2009.  For 2021, economists are projecting a massive rebound in activity after the worst of the pandemic appears to be behind us.   The Atlanta Fed’s GDPNow model projects a +9.5% increase for the first quarter of 2021.11 

The positive economic narrative has many legs to stand on:

  • Consumers have been more or less couped up for almost a year now, are ready to spend and are in better overall financial shape than they were pre-pandemic (more savings, less debt12);
  • More fiscal stimulus is likely to be rolled out this spring;13
  • COVID vaccines are ramping up while new cases drop;14,15
  • The Fed is transparently committed to zero interest rates for the time being.16

The main concern around the economy appears to be whether it is headed to being overheated and how much stimulus is needed as we enter the beginning of the end of the pandemic. 

Two macroeconomic areas to watch in 2021 will be how much the unemployment drops as the economy reopens:

The latest reading was back down to 6.3% from the pandemic high of 14.8%. 

The second area is inflation, and particularly market-based inflation expectations.  Inflation is a probable outcome as the economy heats up in 2021 in light of pent-up demand and flush consumers, but Inflation is a “goldilocks” economic metric – if its “just right” its economic fuel, if its “too hot” or “too cold” it can be damaging. 

Breakeven inflation rates are their highest levels since 2013 – the bond market is signaling that inflation is expected to average 2.5% annually over the next five years.  CPI inflation averaged 1.92% over the 5 years from 2015 to 2019 and has not been above 2.5% for any calendar year since 2011.19

These are the Fed’s two mandates: full employment and price stability.  The market will watch these closely to take the temperate of the economy through 2021 and the reopening phase.

The views expressed herein are those of John Nagle on February 19, 2021 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as, investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. Charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results.  There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.


  1. Morningstar Direct data
  2. Morningstar Direct data
  3. Morningstar Direct data
  4. JPMorgan Guide to Retirement, Slide #43
  5. Morningstar Direct data
  6. JPMorgan Guide to the Markets: On the Bench, Slide #5
  7. Morningstar Direct data
  8. FactSet Earnings Insight
  9. FactSet Earnings Insight
  10. Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/series/GDPC1
  11. Federal Reserve Bank of Atlanta https://www.frbatlanta.org/cqer/research/gdpnow
  12. A Wealth of Common Sense “Why Valuations Probably Won’t Matter For a While” 2/16/21
  13. https://www.cnbc.com/2021/01/14/biden-stimulus-package-details-checks-unemployment-minimum-wage.html
  14. https://www.bloomberg.com/news/articles/2021-02-18/how-many-vaccine-doses-are-available-u-s-should-see-a-surge?
  15. https://covidtracking.com/analysis-updates/more-good-news-this-week-covid-19-data-feb-18/
  16. https://www.cnbc.com/2021/01/14/powell-sees-no-interest-rate-hikes-on-the-horizon-as-long-as-inflation-stays-low.html
  17. Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/series/UNRATE#0
  18. Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/series/T5YIE
  19. Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/series/CPIAUCSL