Q4 2020 Market Review & 2021 Outlook

Posted on January 21, 2021

2020 Recap

2020 will go down in history as a year we all wish we could forget, but never will. While 2020 is defined by some as the year of COVID and by others as the year of the most hotly disputed U.S. election in decades, for investors it was the year of mega-stimulus. The unprecedented coronavirus pandemic changed everything. While the economic and earnings recession was short but deep, the humanitarian crisis remains devastating. 

The U.S. alone has already seen more than 24 million cases (96 million globally) and more than 400,000 fatalities (2 million globally). Around the world, global GDP has declined by $10 trillion, and in April alone more workers lost their jobs than gained jobs in the 10 years following the Great Recession. The pandemic has also left what may be permanent scars on many service industries. ​

After making an all-time high on February 19, stocks collapsed 35% by March 23, making it the quickest and sharpest bear market in modern history. From there, thanks to extremely aggressive global monetary and a number of fiscal “whatever it takes” policy responses, stocks climbed nearly 70%, resulting in yet another double-digit annual percentage gain for the S&P 500 Index. 

For the first two-thirds of the year, U.S., large-cap and growth stocks outperformed non-U.S., small-cap and value stocks. For the rest of the year, however, the latter group outperformed. Political division was rampant in 2020, leading to a bitter November election with Joe Biden being elected over incumbent Donald Trump. Perhaps the year’s biggest miracle was the development of COVID-19 vaccines in just a few months, compared to a more normal period of years.

We enter 2021 with investor optimism running high and equities discounting a lot of good news, raising the question as to whether 2020 has already “borrowed” some of 2021’s returns. With this backdrop, we unveil our best-educated guesses for 2021 forecasts. Before we dive in, let me provide you with a brief update on certain underlying data we like to track to analyze the overall health of the U.S. economy. 

Economic Update


Q3 2020 real GDP was revised slightly higher to 33.4% quarter-over-quarter seasonally adjusted annual rate. Increases in consumption, private inventories, business fixed investment, housing, and exports were partially offset by decreases in government spending and increases in imports. Despite a solid bounce back, economic output is still about 3.5% below its Q4 2019 level. Strong October readings suggest considerable momentum entering Q4 2020, possibly resulting in better than 5% real GDP growth. However, the surging pandemic could mean slower growth at the end of the quarter and into Q1 2021. Retail sales fell 1.1% m/m in November, with broad declines in most categories. However, industrial production rose 0.4% m/m with stronger manufacturing production than expected in motor vehicles and parts.


Nonfarm payrolls increased by 245,000 in November, their weakest pace since the start of the recovery, and the unemployment rate fell slightly to 6.7%. The labor force participation rate fell to 61.5%, with 4.1 million fewer people in the labor force than pre-pandemic in February. Wages grew 0.3% m/m for all workers and production and non-supervisory workers, up 4.4% and 4.5% y/y, respectively. Although 56% of the jobs lost between February and April have been regained, only about 7% of that has come since September, reflecting the enduring challenges of social distancing, health risks, and the surging pandemic to businesses and job growth. Job gains are likely to continue to moderate in the months ahead.


The Q3 2020 earnings season wound down with 464 companies having reported (91.8% of market cap). Our current estimate for Q3 2020 earnings is $37.42 with EPS declining 6.0% y/y. Thus far, 83% of companies have beaten on EPS estimates, and 73% have beaten on revenue estimates, both well above long-term averages, reflecting overly bearish initial estimates thus far. Sectors under pressure in the third quarter were energy and industrials, while consumer staples, technology, and health care had positive earnings growth.


Headline and core CPI rose 0.2% m/m in November, rising 1.2% and 1.6% y/y, respectively. November headline and core PCE were both essentially flat, rising 1.1% and 1.4% y/y, respectively. While low energy prices and slack in the economy continue to put downward pressure on inflation, price pressures appear stronger than what would have been expected in the wake of a downturn as severe as the 2020 recession.


The Fed maintained the federal funds target rate in a range of 0.00%–0.25%. The committee will also maintain its current pace of asset purchases of at least $80bn in Treasuries and $40bn in agency mortgage-backed securities per month until the committee feels “substantial further progress” has been made toward its inflation and employment goals. In its quarterly economic projections, its forecasts for growth, inflation, and employment were all revised higher. While the “dot plot” of future rate projections implies no rate changes through 2023, a solid economic recovery in 2021 and 2022 could result in tapering asset purchases well before rates are adjusted.


  • • The U.S. recession and recovery could be at a slower pace than markets are anticipating
  • • Political headlines could provoke market volatility
  • • Inflation could spike in the medium term


  • • Fixed income investors should move up in quality and look to core bonds for portfolio ballast
  • • Quality with a dash of cyclicality should be a focus for U.S. equity investors
  • • Long-term growth prospects and cheap absolute and relative valuations support international equities

2021 Outlook

It’s hard not to start 2021 with a sigh of relief. COVID-19 vaccines have arrived, contentious U.S. elections are behind us, and five years’ worth of Brexit negotiations have concluded. The worst appears to be over. However, by the time you read this, who knows what will have happened?

We certainly aren’t in the clear yet. Vaccine distribution must now outpace the spread of a significantly more contagious variant of the virus. Most countries won’t return to business as usual anytime soon. Economies will require sustained monetary and fiscal support to continue their recoveries. And concerns are mounting that the second U.S. fiscal package—despite a nearly trillion-dollar price tag—may be not only too late but too little.

For bond investors, this means more of the same: low and negative yields, strong demand for income assets, and episodic market volatility. Here’s how we’re looking to navigate unchartered waters in the year ahead.

Creativity in a Low-Yield Era

The arrival of vaccines increases the odds that global growth will pick up strongly in the second half of 2021, when the virus will likely fade as a cyclical driver. But over the near term, recovery remains fragile, and continued supportive fiscal and monetary policies remain essential.

In this environment, central banks aren’t inclined to let interest rates rise. This means yields are likely to stay very low in most parts of the world for the foreseeable future. As a reminder, the U.S. Federal Reserve indicated in September that it will peg interest rates near zero through at least 2023.

At the same time, volatility remains a risk, given the uncertainty around the new coronavirus strain, the speed and ease of vaccine rollouts, and the timing of reopening.

Under these conditions, a bond portfolio must limit downside risk while generating income and return despite a low-yield environment. Thankfully, the bond markets can still help investors meet both objectives.

Some market observers have suggested that low and negative yields hinder government bonds’ ability to provide a buffer against down markets because bond returns will also be low. We agree that government bond returns will be more muted than in the past because of low yield levels. Indeed, U.S. Treasury returns have been comparatively muted for the past decade, having already reached the lower limits of a downward trend in yields that lasted 30 years.

However, we believe that the argument linking meaningful returns to risk reduction misses the mark, for two reasons.

First, a long history of extremely low yields in Japan suggests that low yields do not necessarily map to low returns. For 11 of the past 12 years, the yield on the 10-year Japanese government bond was less than 1%. In contrast, annual returns over the same period rarely matched starting yield levels. Instead, returns averaged more than twice as much as yields, thanks to a price bump as bonds rolled down the steep yield curve over time. The U.S. Treasury yield curve is similarly steep today, with the slope between five- and 10-year Treasury yields now around the 75th percentile of their average slope since 1962.

Second, amid the dramatic sell-off in risk assets in March 2020 as the global pandemic took hold, and again in September 2020 when equity markets pulled back sharply, government bonds served as one of the few true offsets to equity market volatility. On down days for the stock market, the daily rolling six-month correlation between U.S. Treasuries and the S&P 500 remained below –0.4, despite a 10-year U.S. Treasury yield well below 1%. 

In other words, government bonds became more defensive when defensiveness was needed most. That argues for an allocation to government bonds as an essential buffer during periods of heightened volatility in the risk markets.

Striking the Right Balance

Meanwhile, investors’ need for income and return is as great as ever. Investors looking to make the most of their bond allocation will need to accept the fact that going up in the risk spectrum is a must, which means that pairing exposure to government bonds with a diverse mix of higher-yielding fixed-income sectors. Also, ramping up the exposure in your portfolio allocation to high-quality, low beta equities will be needed to drive higher returns.

In contrast with a traditional, benchmark-hugging portfolio, the balanced portfolio targets the desired objectives of defense plus efficient income. This approach capitalizes on relative value opportunities while taking advantage of differing correlations among sectors.

That’s because the two groups are negatively correlated during risk-off environments, much like U.S. Treasuries and stocks. In other words, safety-seeking assets such as government bonds tend to do well when return-seeking assets, such as high-yield corporates, have a down day.

In addition, if managed dynamically, such a portfolio can tilt toward either exposure as market conditions change. Further, an active investor can take advantage of opportunities as they arise.

Sourcing Income and Potential Return

Today, we see opportunities—and attractive yield—in:

Emerging-market debt, particularly high-yield sovereign credit. We expect the sector to be buoyed by the weaker U.S. dollar, fiscal stimulus, attractive valuations, and strong investor demand for income in a low-yield environment.

U.S. securitized assets such as credit risk–transfer (CRT) securities—residential mortgage-backed bonds issued by U.S. government-sponsored enterprises—and commercial mortgage-backed securities. CRTs benefit from a still-solid U.S. housing market, among other positive factors. Securitized assets have low correlations with other fixed-income sectors and other asset classes, and they offer a healthy yield pickup over corporate bonds.

Global high-yield corporates. Indeed, spreads tightened significantly in 2020 following the pandemic panic. But the quality of the high-yield market has also improved, thanks to weak credits defaulting (and exiting the market) even as relatively strong fallen angels—bonds initially rated investment-grade that are downgraded below investment-grade—joined it. That improved credit quality spells room for further spread narrowing and attractive relative return potential.

US investment-grade credit. The weakening pace of issuance in 2020 foreshadows much slower issuance in 2021, even as income-hungry investors drive strong demand for U.S. corporate debt. The result? Highly supportive technical conditions. Meanwhile, the dispersion of credit spreads has increased, indicating the potential for unique opportunities. It’s especially important to be careful in this kind of environment. Fundamentals matter.

Stay Active, Be Selective

Today’s era of low yields and heightened uncertainty isn’t likely to end soon. But selective investments across regions and sectors, as well as a suitable balance of interest-rate-sensitive and credit-sensitive holdings, can help reduce volatility and increase return potential as the world economy recovers.

Investors who actively manage their bond portfolios using this dynamic approach should be well-positioned to navigate rough seas.

In the opening months of 2021, the short‑term economic risks from a worsening pandemic could weigh on global equity and credit markets. However, economic and earnings growth could improve dramatically later in the year if the new vaccines can rapidly bring down infection rates. 

But a 2021 earnings recovery might not translate into continued strong rallies in global equity prices. To a large degree, an economic and earnings recovery already has been priced in by the markets. Expectations are high, so we could see good earnings results but still see the market trade off a bit. We believe global equities could perform reasonably well in 2021, helped by the same factors that propelled the 2020 rally: supportive fiscal policy and ample monetary liquidity. A lot of money on the sidelines could make its way into risk assets… it’s just a matter of time. 

For fixed income investors, 2021 could be challenging, as the falling yields and tightening credit spreads that boosted broad market returns in 2020 aren’t likely to play that role again. Rather, extended durations and the potential for a modest revival in inflation could make managing interest rate risk a portfolio priority, boosting the appeal of floating-rate assets. 

Most of us didn’t time the bottom perfectly or navigate this year with a surgeon’s precision. But, success in the markets doesn’t require precision, just the ability to stay in the game. There will always be people who make more money than you in the markets or life in general. Worrying about this fact of life is pointless. Someone will always be richer, or have better performance numbers, or pick better stocks than you. Even people who seem like they don’t deserve it. Life isn’t fair, nor are the markets. 

It’s worth remembering what your personal goals and circumstances are when you hear so many people bragging about how much money they made or how huge their returns have been. As long as you stayed true to your investment plan and continued making progress towards your personal and financial goals, that’s a win in my book. 2020 may look easy with the benefit of hindsight, but it most certainly was not for those of us who lived through it. If you survived 2020 as an investor without making an avoidable or unnecessary mistake, you outperformed this year. 

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