Outlook 2021

As 2021 begins, the vaccine for COVID-19 could soon return our economy to normal. However, “normal” may prove to mean something other than what life was like in 2019, before the pandemic took hold. An unknown number of businesses will have failed to survive. The habits of citizens regarding dining, travel, and entertainment may prove to have been altered permanently. Although economic and political uncertainty is unusually severe, we must do what we can with the information that is at hand.

The economy

There has been considerable debate over how quickly the economy may be able to recover from the pandemic. Interest rates can’t go much lower, so economy will have to begin to grow on its own.

Housing starts recovered during 2020, and are already close to pre-pandemic levels, in part thanks to the continued low interest rates. Commercial real estate may be another matter. The success many companies had with having employees work from home may have altered business dynamics for the long term, suggesting that we have an oversupply of office space in many cities. The continued shift of consumer preferences to making purchases online offers a similar grim outlook for retail commercial space.

Equities

The large-capitalization stock indices have largely recovered from their pandemic-induced lows of March 2020. That’s welcome news, but it is also a signal for caution.

The price of a stock is what an investor is willing to pay for a stream of future earnings. Therefore, the price/earnings ratio is a measure of how expensive a stock is relative to its expected earnings. The S&P 500 P/E ratio was very high as 2020 closed, as high as it had been since the dot-com bubble of 2000. For perspective, over the past 15 years, that ratio has been higher only 0.5 percent of the time.

Three factors may account for this. Earnings contracted sharply as the lockdowns were ordered, have not yet fully recovered, and prices may have gotten ahead of earnings. Investors may be looking beyond the current reports to a future in which the vaccine has led to a return to the robust economic growth of 2019.

With interest rates so low, stocks may be seen as the better alternative for many investors. Finally, the S&P 500 may be perceived by many as a “safe haven.”

Smaller capitalization stocks are not trading at such high P/Es, perhaps because investors are worried that smaller companies don’t have the resources they may need for recovery. The S&P mid-cap 400 P/E has been higher only 16 percent of the time, while the S&P small-cap 600 is 0.2 percent below its 15-year average. It has been higher 66 percent of the time.

* Comparisons to major indices are for illustration purposes only. It is not possible to invest directly in an index.

Bonds

Bond prices rise as interest rates fall, and those rates have been falling since 1980. The 40-year bull market for bonds may be coming to an end. In March 2020 the 10-year Treasury bond hit an all-time low of 0.32 percent, but it has been generally rising since them. The yield curve is positive and steepening, suggesting that investors see a better economy ahead with the possibility of a return of inflation.

The Federal Reserve is expected to keep short-term interest rates low throughout 2021. The Fed has set an inflation target of 2 percent, and further modified that last September to an average rate of 2 percent. That means that months of little to no inflation will be taken into account before there is another rate increase. Accordingly, mortgage and corporate borrowing costs are expected to remain low this year.

*All offerings are subject to price change and availability. This information is obtained from internal and external sources which are believed to be reliable, however, no guarantee of its accuracy can be made. Due to fluctuating market conditions, yield/principal value may be higher or lower if security is sold prior to maturity. Bond offering yields include calculations which are the lower of the yield to maturity or the yield to call.

Reprinted from QuarterNotes which is written by The Merrill Anderson Company. Matthew A. Cyr, AIF, a senior vice president and senior financial advisor and program manager with S & B Financial Services in Saco can be reached at 888-978-7526.

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