Horrible year

In 1992, the troubled marriages of her children, particularly the Prince of Wales, and a major fire that engulfed Windsor Castle damaging and destroying materials of major historical significance, led the Queen to pluck an uncommon Latin phrase from obscurity in a speech marking her Ruby Jubilee. 1992, according to the Queen, had turned out to be an annus horribilis, or a horrible year.

Funny enough, 2020 was also marked by troubled relationships and spiking divorce rates around the world, as lockdown woes took their toll on fragile marriages. Meanwhile, large bushfires engulfed various regions in Australia amid a season of severe drought from mid-2019 right up to the first half of 2020. Protests that turned unruly and violent led to the burning of major cities in the US. Add to that a global pandemic and the attendant public health and economic ramifications, and you have the ingredients for yet another annus horribilis.

Jubilant markets

Yet, this would not be obvious from looking at the stock market. In the grips of one of the worst crises in modern history, the stock market paints a picture of buoyancy and hope. Tales of economic pain seems far removed from Wall Street, as major market benchmarks notched fresh record highs in almost rapid succession, in sheer disregard of Main Street’s economic tribulations.

Of course, financial markets are forward looking, and prices reflect expectations of what will be and not what is. If anything, investors seem rather optimistic that the worst is behind us and that the economy will bounce back robustly in the new year. This is, after all, not your run-of-the-mill boom and bust cycle or one driven by imbalances in the system.

Not your run-of-the-mill recession

The Covid-19 global pandemic can be thought of as a negative exogenous demand shock whose initial impact is swift and severe, but seldom persists for very long as the adverse effects recede with time. Indeed, during the initial phase of the virus, governments all over the world resorted to imposing severe lockdowns, shutting down large swathes of the economy, in order to alleviate pressure in hospitals that were already functioning near the limits of their capacity as the number of positive cases and deaths swelled. This caused economic activity to collapse and unemployment to spike. However, with time, governments became more adept at handling the outbreak and were mostly able to contain the spread of the virus without having to shut down the economy entirely. Economic activity gradually recovered as countries reopened. Yet, social distancing measures meant the economy could not fully recover to 2019 levels of output. For this to happen, a permanent solution to the health crisis must be found. And indeed, it has, and in record time at that.

The world, crippled by an invisible enemy, raced to find a vaccine. The US’ Operation Warp Speed was by far the most successful. The US government removed any obstacle (within reason), both regulatory and financial, to shorten and smooth the path towards the discovery of a credible vaccine. Moderna’s success was its crowning achievement – a public-private partnership that delivered a solution in less than a year. For perspective, it typically takes about 10 years to develop a workable vaccine. Indeed, 2020 will be remembered not just for all the economic pain and anguish that the virus wrought, but also the accomplishments of tireless scientists who delivered hope to a world quite literally struggling to breathe.

For 2021, the focus will be about turning vaccines into vaccinations. This will test the efficiency and effectiveness of the public health system in delivering vaccine shots to large segments of the population. We could easily go down the rabbit hole of the potential operational hurdles that governments will face in the process of inoculating the world from this virus, but this would be missing the broader point. There is now a clear path back to economic normalcy. It is bound to be uneven and rocky, but the destination is clear. It’s a question of when, not if. As it stands, super forecasters surveyed by the Good Judgment Project places the likelihood of 200 million people being inoculated in the US by end-September 2021 at 84%, a sharp jump from 64% just a month before Pfizer’s fateful vaccine announcement last year.

There is a great deal of pent up demand looking for an outlet as economies gradually normalise. As it stands, the personal savings rate in the US remains high by historical standards, even as household net worth recovered back to pre-pandemic levels. The stabilisation of public health and economic conditions might break the dam on deferred spending, allowing consumers to spend more freely. This may help the economy bounce back strongly in 2021. It’s up to governments to provide the bridge to this end state as the virus continues to spread at an unrelenting pace. Containment of new infections coupled with widespread vaccinations should help ensure the crisis remains short lived. To this end, the market may be right to be optimistic.

Indeed, the speed at which the market recovered also reflected the decisive and unprecedented scale of government support, rendered rather swiftly on both the fiscal and monetary policy fronts. The 2008-2009 Global Financial Crisis taught governments and central banks that clear, decisive and dramatic policy actions were necessary to cushion the blow on Main Street and preserve confidence in the financial system among investors to keep credit flowing to suffering businesses. Interest rates were slashed, and the (digital) money printing presses were set on overdrive, as central banks like the Federal Reserve revived quantitative easing policies alongside implementing other extraordinary lending programmes.

Other central banks followed suit, laying out a huge safety net under financial markets with unprecedented levels of monetary stimulus. The “do whatever it takes” policy posture buoyed market confidence and fomented conditions for one of the fastest market recoveries on record. 2020 was indeed a banner year for financial markets.

Three lessons

Amid the turbulence of a virus-wrought year, there are some key lessons to be gleaned.

1. Stay invested and dollar cost average

The sell-off in March was certainly harrowing, and indeed investors who had sold on bad news and waited for clear skies would have missed out on a significant chunk of the stock market rally. The S&P 500 index gained about 68% from the trough hit on 23 March to the new year. Investors who bought the S&P 500 index at the beginning of the year would have enjoyed about 16% gains just by staying invested throughout the year.

If there was one lesson in 2020, it would be that timing the market was a fool’s errand. It was nearly impossible to predict with any form of precision and confidence where the market was headed to next amid a year of unprecedented macro-economic shocks and political noise.

The upshot was heightened market volatility. Investors who looked through the turbulence and bought the S&P 500 index gradually via a dollar cost averaging approach throughout the past 12 months would be sitting on fairly decent returns, even slightly outperforming those who had invested lump-sum at the beginning of the year. Dollar-cost averaging worked better in mitigating the impact of down months in the first quarter of 2020, primarily because the investor’s capital was not fully deployed into the stock market.

2. Don’t just bank on growth stocks

In a year where many were confined to their homes and had to quickly adopt digital solutions to stay connected, procure goods and entertain themselves, it’s little wonder that tech companies saw immense investor interest.

Indeed, a narrow base of growth stocks had propelled the broader S&P 500 index higher as investors increasingly bid up the prices of stay-at-home winners like Facebook, Amazon, Apple, Alphabet and Microsoft. Tesla mania was equally palpable with its stock spilt and inclusion in the S&P 500 index triggering a flood of retail participation. The year also saw the emergence of Robinhood traders, a group of young and digitally savvy investors who used the namesake app to trade fractionalised shares and options. Stocks of predominantly tech players like Snowflake, Airbnb, and DoorDash soared on its first day of trading in 2020, fattening the wallets of early investors. Indeed, it was a record year for growth stocks, including marquee tech names and less known cloud and electric vehicle players.

The narrow breadth rally in the first half of the year was hardly healthy for the market. A correction was in order after growth stocks rallied to dizzying heights and traded at seemingly unrealistic price-to-earnings ratios. A correction swiftly came in August and September, which in retrospect merely dented prices, not pummelled it.

The market rally broadened later in the year with value stocks joining the party, enjoying a late tailwind from the confluence of two seemingly positive news: Joe Biden’s election victory and the announcements of efficacious Covid-19 vaccines from Pfizer/BioNTech and Moderna. Vaccine news offered hope of a quicker-than-expected return to economic normalcy. Meanwhile, a Biden presidency allayed concerns about volatile policymaking vis-à-vis China and increased confidence about a more effective handling of the Covid-19 health and economic crisis.

As a result, the re-opening trade gained momentum as investors rotated from growth to depressed value stocks, including companies in unloved sectors such as airlines, cruise operators and financials. While value stocks rallied in the last two months of 2020, it was insufficient to offset the deep losses from the virus-triggered sell-off in March. Still, there was significant recovery from the depths of the virus-induced sell-off.

This trip down memory lane serves to remind us that market leadership is seldom permanent. Shifting sands can quickly shift market prospects. Yet, events that trigger these shifts are often unpredictable. One would like to think that they could have perfectly timed the start of a multi-week rally for a particular sector and quickly rotate into others that become in-vogue later. Alas, these trades will never be perfectly timed.

Hence, reviewing and rebalancing portfolios periodically is important to account for new information so as to ensure portfolio positioning remains relevant for the next run, especially in a turbulent year. For instance, investors who were over-exposed to growth sectors could have taken some profit off the table during the second half of the year and rotate into quality laggards which rallied on the revival of reopening hopes after positive vaccine news emerged.

Also, in lieu of market timing, a growth and value “barbell” equity investment approach might have been useful in retrospect. This investment strategy weights a portfolio towards two extreme ends of an asset class – growth and value for example – providing investors exposure to both stay-at-home trades and the reopening theme. The strategy stresses the importance of patience and diversification. Investors should always have exposure to growth names that will benefit from long-run secular trends, but they should also be mindful not to be over-exposed to these volatile sectors.

Quality stocks of tried-and-tested businesses with strong balance sheets and reliable earnings should have a place in one’s portfolio, even if they don’t appear in-vogue at the time. It’s not a choice of one or the other, but an optimal mix of both. The past 12 months underscore the wisdom of such diversification in seemingly stark terms.

3. Ignore Asia ex-Japan at your peril

While popular attention often focused on the US stock market, Asian markets surprised on the upside as well amid a tough year for global demand. Countries that had fared fairly well in containing the Covid-19 pandemic such as South Korea, Japan, China and Taiwan enjoyed positive market returns for the year. Surprisingly, India’s Sensex index and Malaysia’s FTSE Bursa KL Composite index also ended in the green for the year despite struggling to contain the spread of Covid-19.

Singapore’s local bourse did not fare particularly well in 2020, with the Straits Times Index posting a decline of 11.8%, but the recovery or reopening theme in 2021 should favour the cyclical-heavy market and potentially result in a re-rating of Singapore stocks. As it stands, Singapore has already entered Phase 3 of its reopening efforts which point to further normalisation of economic activity. The widespread distribution of vaccines, recovering global demand and the persistently low interest rate environment should provide a cyclical tailwind for local stocks.

The thirst for growth stocks also found its way into Asia. Investors could rattle off strings of seemingly random numbers like 700, 9988, 9618 and 9999 to their brokers as easily as placing an order at your neighbourhood McDonalds. For the record, these numbers are the tickers for Tencent, Alibaba, JD.com and NetEase respectively. Yes, Asia has its technology behemoths too. The stay-at-home trade benefited Asia tech, pushing the Hang Seng TECH index up more than 80% in 2020. Likewise, China’s healthcare stocks rallied more than 60%, as investors scoured the globe for potential winners in the Covid-19 era.

One would not have guessed that the country which was the initial epicentre of the health crisis, could contain its problem, in record time no less, and drag the broader region along with it as it climbed out of its short-lived economic contraction. By this, we’re referring to China and Asia ex-Japan more broadly. Economic data remains favourable for continued growth in the region.

Indeed, ignoring opportunities in Asia ex-Japan in 2020 would have cost portfolios decent returns. After all, as Chart 8 shows, it was the best performing region last year. This underscores the need to adopt a global perspective when investing as it widens the opportunity set and may potentially improve risk-adjusted returns.

Stay invested and stay diversified

The long and short of investing in 2020 is to stay invested and stay diversified across sectors and regional markets. While the new year brings hope of a return to normalcy as the vaccine rollout begins in earnest, we should still have our eyes wide open to the potential risks ahead.

The virus continues to spread at an unrelenting pace, and it is yet unclear if a Biden administration would work towards calming US-China tensions and whether they would be successful in providing further significant stimulus support. In the face of these risks and uncertainties, staying invested and staying diversified might be the best solution to ride out potential volatility.