Jeanette Garretty, Chief Economist, December 29, 2020
As published in wealthmanagement.com
Although clients will start 2021 buoyed by portfolios that have appreciated and pandemic risk that may be subsiding, numerous uncertainties and risks loom.
Everything happened fast in 2020. The recession, identified as having started in late February, ended in late June or early July. The economy then entered a surprisingly robust recovery phase and the stock market rebounded to record highs. While this is much better news than might reasonably have been expected in March 2020, the speed of these developments can make them difficult to absorb and, coupled with a general misunderstanding of what happens in an economic recovery, leave clients ill-prepared for investment decisions in 2021.
For the purpose of managing wealth, there is no more-important understanding of the economic environment in 2021 than that of the recovery which will distinguish the year and leave it on the cusp of economic expansion. Economic recoveries are always uneven, often disappointing and frequently take longer than desired. Many things commonly associated with recessions – e.g. bankruptcies, layoffs, factory closures – actually peak during the recovery phase of the economic cycle. The unexpected, bad-news financial headline can introduce a concern that the recovery has “stalled” or that the recession never ended, causing individuals to re- evaluate their investment decisions and incorrectly assess risk. The economic recovery of 2021 is further complicated by the likelihood that there will not only be the usual cyclical adjustments that benefit sectors such as residential construction, auto production and consumer goods, but also structural changes of considerable magnitude – in health care, energy and commercial real estate, to name just a few. Whereas cyclical factors play out in a relatively short time frame, structural factors are longer, more enduring and can play a critical role in determining investment opportunities during the entire, lengthy, economic expansion to come.
An additional challenge for wealth management in 2021 is presented by the exceptionally low interest rates that are forecast to continue well into 2022. Short term interest rates that hover at zero make maintaining large cash positions while “waiting for things to settle down” painful; forecast inflation of 1.6%-1.8% quickly turns the value negative. Paradoxically, the same investor who holds large amounts of cash as protection against equity volatility during the economic recovery is also likely to be an investor that assumes greater risk and unwisely stretches for yield in order to counter the lack of return in cash and cash equivalents.
Staying invested in 2021 and preparing for the new economic expansion is Job #1 for wealth managers. The “fairly priced” US equity market makes the hard work of identifying overlooked, and therefore less overbought, investment opportunities all-important. International markets, real estate, private investments, and well-managed companies in “traditional” industries that are quietly transforming all offer interesting possibilities and relatively lower valuations. Technology, however, is likely to be such a dominant force in global economic recovery and growth that it cannot be easily ignored, even if the valuations are high—a lesson taught, and perhaps learned, in 2020. Years ago, no portfolio positioned for economic growth would have been without exposure to steel and autos and heavy machinery; today’s economic growth stalwarts are technology companies.
Finally, the 2021 economic environment may be distinguished by a number of new economic policies. Massive changes to estate or income taxation are unlikely, but the situation bears close watch. At minimum, with high PE’s and low interest rates constraining portfolio growth rates, it is critical to keep an eye on after-tax returns and upfront fees.
Jeanette Garretty is Chief Economist of Robertson Stephens, a wealth management firm striving to provide comprehensive and innovative investment solutions and wealth strategies to its clients through an intelligent digital platform.
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