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Economic Highlights

• The COVID-19 vaccinations are underway in the US and most of the world, but the spread of the disease and the new strings continue putting pressure on the economy, healthcare, and travel and leisure.

• The reported Q3 GDP has increased at an annual rate of 33.4%, continuing recovery from the lock-downs of Q1 and Q2.  Consumer spending, real business equipment spending, and housing activity all continued to recover as well.

• Payroll employment recovery has stalled, while the corporate earnings recovery has turned a corner.

• With the change in the White House, a new era dawns, full of its own set of hopes and challenges.

• The COVID-19 second stimulus package is now expected to be one of the first orders of business in the new Congress.

Market Highlights

• US Equities rally continued into December, and S&P 500 Index closed up 3.8%, capping the 18.4% rise for the year.

• Foreign equities also rallied and again outperformed domestic equities, with Developed Markets up 4.7%, (7.8% on the year), and Emerging Markets also up 7.4% (18.3% on the year).

• US high-grade bonds added up 0.1%, while the high yield rallied with risky assets and added 1.6%. Foreign high-grade and high-yield bonds also rallied 2.7% and 3.0%, respectively, and Emerging Markets bonds added 2.4%.

• Commodities also rallied 5.0%, helped by big moves in oil, up 7.0%, and gold, up 6.6%. Oil ended the year down -20.6%, while gold was up 25.0%.

• US Dollar drop another -2.1%.

Observations and Expectations

What a difference a year makes. This is how we started our market commentary in January of last year.  It’s just as relevant today, and hopefully will still be relevant next year.  Because every year brings its unique challenges, and 2020 certainly exacerbated that notion.  Few aspects of our lives have remained unchanged through the unprecedented pandemic.  Yet, despite the tragic loss of lives, suffering and initial economic devastation, the anticipated and continuing recovery has lifted the markets, like few have anticipated.

We’ve been fortunate enough to identify likely winners and losers in the quickly changing environment early, and switched gears, to benefit our clients’ portfolios tremendously.  The additional post-election timely rebalance was another boost to the portfolios.  We’ll take another victory lap on the banner investment year.

Looking forward to January, all eyes will be on the new Administration in the White House and the tone they will set.  The pace of the COVID-19 spread vs. the pace of vaccinations will also be closely watched.  And last, but not least, the Q4 earnings reports and 2021 targets and outlooks for the Corporate America will matter again.

As the markets digest some big gains in 2020, we expect certain market rotation and change in market leadership to take place in the near term.  Some pullbacks are also likely.  However, the long-term trend remains bullish, we believe. More on this in our Question of the Month.  On a relative basis, we see some opportunities in foreign equities, especially in the post-Brexit Europe and post-Trump China.  The other area of opportunities may be in commodities and related equities that appear to be in an early business cycle.  However, innovation and impact investing remain constant growing themes.

Sector Update

Consumer Discretionary as a sector had the most to gain from the vaccinations and economic recovery.  The hope is that the pent-up demand for travel and entertainment goods and services will come roaring back as soon as it’s medically safe.  Yet, that time still seems pretty far away.  And while the equities have already run up quite a bit in anticipation, the businesses – big and small – continue to bleed red ink.  A pullback is likely in the cards, and that’s an optimistic view.

Materials sector is without a doubt cyclical.  In fact, as opposed to even other cyclical sectors of the economy, it usually acts as a leading indicator.  Before manufacturers can ramp up production, they need to order raw materials. Copper, for instance, is known as “Dr. Copper” because it has a Ph.D. in economics.  Hence, it should come as no surprise that, as the world economy recovers, the materials sector is leading the way, albeit quietly.  The acceleration of green energy transition, smart cities, 5G and general infrastructure upgrades, as well as lower dollar are all significant tailwinds for the sector.

Impact Investing has had a breakout year. Many of the leading market themes fall under the impact investing umbrella and resonate with investors, particularly the younger generation. President Biden’s agenda also bodes very well for this trend to continue in the foreseeable future.

Question of the Month

This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.

Question

Is it time to switch from growth to value?

Answer

This question keeps coming up in one from or another.  Perhaps the more direct question is, are we in a bubble territory and is it perhaps time to reduce risk?  Of course, it’s always easy to explain the past, but everyone would like to know what tomorrow brings.  Naturally, the answer, as with most things in life, is: it depends.  And the key factor it depends on is your time horizon.  Let me explain.

Growth stocks tend to rely on organic growth due to increasing market opportunities.  Value stocks are traditionally defined as more steady and mature businesses, with predictable cash flows, typically paying dividends and trading at low valuation multiples.  Historically, value and growth styles trade places for periods of business cycles.  Usually, when economy goes through an expansion, growth is in favor, while value doesn’t move up as much.  In periods of slow growth and especially recession, however, growth stocks may suffer significantly more than value stocks.  The value and growth styles are thus often treated as broad approximation of risky vs. conservative investments.

The chart below uses the most common Growth and Value ETFs (IVV and IVW, respectively) to show relative performance over the past 20 years.  The value has outperformed in slow growth and recession times (2004-09) but underperformed the rest of the time.  In fact, the growth style has outperformed significantly over for the past 5 years and especially in the last nine months of 2020.

On one hand, that amplified the calls for reversion to the mean.  On the other, it has underscored the difference this time around. Who is right?

The argument I’d like to make is that things are different now.  We no longer find ourselves in just ordinary times.  We are in fact in the midst of an industrial revolution.  To take a quick history detour, there are three distinct industrial revolutions occurring in the Western society in the past 250 years or so and they all have these common properties:

1. Science and technology led to new manufacturing paradigms

2. New energy sources emerged

3. New transportation and communication services were introduced

4. All of the above led to significant improvements in quality of life

The first Industrial Revolution started in England in 18^th century and was characterized by new manufacturing processes based on chemicals and iron production processes, supported by steam and water power.  They led to the rise of mechanized factories and eventual unprecedented urban population growth.  The Second Industrial Revolution, also known as the Technological Revolution, that started around 1870, saw the manufacturing innovations that established the machine tool industry and led to the assembly line, aided by the rise of electrical power.  Railroads, automobiles and planes have revolutionized transportation, while the telegraph, radio and telephone changed communications forever.  The Third Industrial Revolution (also known as the Digital Revolution) has begun in the second half of the 20^th century.  It was precipitated by the invention of transistor and development of semiconductors to produce digital devices and communications, that led to personal computers and the Internet.  At the same time, the new energy source of nuclear power has allowed for another leap in manufacturing and urban development.

The case is to be made that we’re on the brink of the Fourth Industrial Revolution.  Breakthroughs in fields such as artificial intelligence, robotics, the Internet of Things, autonomous vehicles, 3-D printing, nanotechnology, biotechnology, materials science, energy storage, quantum computing, satellite communication, and commercial space travel cover all the necessary preconditions described above and lead to a potential explosion of new products and services to benefit humanity.  It is the sheer scope, exponential speed and global impact of these breakthroughs that makes this coming surge so astounding.  And, perhaps paradoxically, the pandemic has accelerated many of these breakthroughs.

In conclusion, it’s true that over the past few decades the growth and value styles have competed for investors’ attention and each outperformed for a period of time.  However, during the times of unparalleled growth such as the Industrial Revolution, growth trumps value over any significant period of time, except the very short time horizons.  We believe that some of the themes above and others likely to emerge will lead long-term investors to significant market outperformance, painful but short-lived pullbacks notwithstanding.

Investing Hot Reads

• 10 Hot Investment Themes For 2021 (ThinkAdvisor)
• Value Is Why Quants Underperformed (Institutional Investor)
• Biden's stimulus plan includes $1,400 checks (CNBC)
• After 1700% Asset Growth, China Poised To Lead ESG Asia Push (Bloomberg)
• Blue Wave Unleashes $1B Of Demand For Clean Energy ETFs (Bloomberg)

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