December 30, 2020
When I started in the industry in the late 1980s, I was under the tutelage of some “old school” Wall Streeters who seemed to be always spouting off various axioms about the investment industry. I loved it. One that stuck with me was “Don’t Fight the Fed”. Of course, as green as I was back then, I had no idea what they were talking about. Yet now there may not be an axiom as true or as relevant as this. Following the U.S. central bank’s December policymaking conference, Federal Reserve Chairman Jerome Powell told reporters that the Fed would increase its balance sheet expansion and easy monetary policy if it became clear that the recovery had slowed. “Our guidance is outcome-based and is tied to progress reaching our employment and inflation goals. Thus, if progress slows, the guidance will be to increase policy accommodation with a lower expected path of the federal funds rate, and a higher expected path of the balance sheet” he said. “Overall, our interest rate and balance-sheet tools are providing powerful support for the economy and will continue to do so.”
Wow! In response to his comments, Evercore ISI strategist Dennis DeBusschere noted that the Fed’s current stance is “max dovish” at $120B of bond purchases per month! Mr. DeBusschere said, “Powell has successfully reassured the markets that policy remains highly accommodative as the economic recovery progresses.” Other central banks around the world have undertaken similar, unprecedented, open-ended quantitative easing in response to COVID-19. Although the general global economy appears shaky, the vaccine provides markets with cautious optimism in 2021. The timing of a recovery is unclear; it depends on how quickly governments can vaccinate the at-risk population. Nevertheless, it does not appear that government and central bank support is going away any time soon. The market’s phrase for what is happening is “lower for longer” interest rates. Bond market futures suggest that rates will stay low through 2022, although broader quantitative easing is less clear. Central banks don’t want market volatility or corporate defaults due to a loss of investor confidence that could cause falling demand.
We expect inflation to remain low across developed markets throughout 2021 and into 2022, as economies struggle to recover from the pandemic and lockdowns and work through higher unemployment. What all this means is that 2021 could turn out to be a good year in the market, as cyclical sectors bounce back. We are expecting an uneven recovery and remain diversified across asset classes. In short, we are still fully allocated to equities in view of essentially zero interest rates. Although the forward price-to-earnings (PE) ratio is elevated at 22X, the market appears to be comfortable with this level. However, whenever markets are trading at or near all-time highs, it’s important to remain vigilant. We are optimistic about a COVID-19 vaccine led scenario, but there will likely be bumps along the road to recovery. We recommend remaining diversified and disciplined into 2021.