Good riddance 2020! That sentiment, which by now we have all probably heard enough, was coming from pretty much everywhere in December… except investors. Amid all the tragedy, controversy and struggle experienced around the world in this unforgettable year, investors may be saying, “Give me more of the same!” and December’s action in the markets did nothing to dampen this enthusiasm. The S&P 500 finished the month up by 3.84%, locking in a great calendar year return of 18.40%. The rotation in leadership we witnessed in early November continued in December, with small- and mid-cap stocks outperforming large caps again as economic normalization gets closer each day now that vaccines are being distributed. Large cap stocks still won the year, but the calendar year returns for small- and mid-cap stocks went from disappointing through the first ten months to very solid by the end of December, 11.29% and 13.66%, respectively. International stocks, developed and emerging, also finished the year on a strong note, gaining 4.65% and 7.35% during December, propelled both by hopes of normalization and a weakening US dollar. Bond returns were modest in December as rates rose slightly, with the yield on the 10-year US Treasury Bill increasing from 0.84% to 0.92%. Most bond investors should be pleasantly surprised with their returns throughout all of 2020, buoyed by interest rates falling significantly early in the year in response to COVID. The Bloomberg Barclays US Aggregate Bond Index notched a 7.51% return for 2020.

What does 2021 have in store for us? One of the first potential threats of turbulence will hopefully be resolved around the time this newsletter is published, as the two run-off elections for Senate seats in Georgia will take place on January 5^th. If Democrats pull off the upset and win both of those races, the chance of taxes going up in the next 24 months goes from near 0% right now to something much more realistic. Regardless of the merits, or lack thereof, of a tax hike, such policy would likely give the markets some heartburn in the near term. However, if Republicans win even one of those races, this market threat will be off the table until the 2022 midterm elections.

Next, investors should pay close attention to earnings season as it begins in mid-January. These quarterly events are always informative about the health of various public companies. Obviously it will be interesting to see how companies performed in Q4—the current forecast for companies in the S&P 500 is a year-over-year earnings decline of 9.7% (FactSet, December 18)—however what market watchers will likely care more about is the guidance for 2021 provided by corporate executives. The current estimate for 2021’s earnings growth of the S&P 500 is 22.1%— the largest it has been since 2010. While it is true that much of 2021’s comparative growth is due to the low hurdle set by 2020’s sharp declines, investors should be encouraged that 2021 estimates have been steadily increasing in recent weeks and months. This signals that corporate executives and the analysts that follow them are increasingly optimistic about the outlook for 2021.

Another factor to watch in 2021 will be the Fed. As it stands now, the Fed is extremely accommodative in its policy and has signaled that it intends to continue that way indefinitely. This creates a bullish setting for stocks. There are a couple of things that could cause the Fed to change its tune sooner than expected. For one, the labor market recovery could accelerate beyond its current trajectory. If unemployment and wages approach pre-COVID levels sooner than the Fed anticipates, Chair Powell may be compelled to at least adjust the committee’s public forward-looking guidance. Secondly, inflation may begin to tick up. Fed watchers have been wondering where inflation has been since 2010 and are understandably gun shy in calling for it now because of that, but the unique disruptions of global economic supply chains combined with low interest rates may be a recipe for increasing prices. If the Fed’s inflation indicator begins to run consistently above 2%, this may also cause the Fed to implement tighter policy sooner than expected, and this could upset markets.

2020 taught investors not only that they should be prepared for the unexpected, but also that the unexpected may have counterintuitive effects on the market and their portfolios. No one knew the world would be upended by a pandemic in 2020, and few would have anticipated such strong equity returns in the same year (albeit with a brief, severe bear market). It was the ultimate lesson in focusing on what you can control—namely your diversification and risk—and accepting what you can’t control. We encourage readers to take that lesson and translate it into practice in their portfolios as we move onto 2021.

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