Newsletter
2020, a year that most are happy to leave behind, will go down in history as unprecedented on many levels. Since our July newsletter we have witnessed unparalleled progress to find a cure for COVID-19. With two vaccines already being administered and several others in late-stage trials, the benefits for humanity go without saying. From an economic standpoint, the outlook for 2021 looks much brighter than it did 6 months ago.
A vaccine alone will not be enough for the U.S. and countries around the globe to return to normalcy in short order. Accommodative monetary policy along with continued fiscal stimulus must continue at extraordinary levels in the near term. Fed Chairman Powell has vowed to maintain a low interest rate policy and incoming Treasury Secretary Janet Yellen is known for her accommodative stance. Although drastic fiscal and monetary policy was a necessity, the potential ramifications of a prolonged zero interest rate policy in the U.S. remain to be seen.
There are short term positive effects of low interest rates for borrowers, the economy, and asset prices. However, extremely low interest rates can encourage undue risk taking. The extraordinary rally in stocks from the March crash to a new high in December was partially a result of The Federal Reserve’s low-rate policy. We aren’t suggesting that the overall stock market is severely overvalued, but there are some areas where valuations are stretched. Parts of the technology sector, some of the recent IPO’s and other “stay at home” stocks with outsized gains are due for a correction. Having said that, we believe that equities can generate positive returns for 2021 and our portfolios are positioned appropriately in high quality corporations that will benefit as the country reopens.
Undue risk taking can also apply to fixed income as well as equities. Along with equities, bond prices have soared in 2020 as treasury yields have dropped and credit spreads tightened. Much of this move lower can be credited to the Federal Reserve’s extraordinary bond purchases since March. Many sectors of the credit markets are trading at or near historically low yields. For example, an “A” rated, high quality 10yr corporate bond yields 1.30%, although not inherently risky, corporate debt is not very attractive from an investor perspective. High Yield or “Junk” bonds, aptly named for their risk of default, offer yields in the 4-5% range. Again, given the risk/reward, lower rated debt is not an area where we would allocate cash. Thus, given the current low yield on bonds, we believe that many sectors of the equity markets offer better value. This is not to say that we have completely abandoned the fixed income markets as diversification is always prudent. However, our bond positions are limited to legacy Mortgage- Backed Securities (MBS), high quality, short duration funds, and preferred stocks which have fixed income characteristics.
In summary, we aren’t anticipating sizeable gains in risk assets for 2021. However, we do believe gains near historical averages are achievable with asset allocation being more important than ever. We also expect The Federal Reserve to maintain their “do whatever it takes” policy thereby supporting asset prices in their drive to stimulate the economy.
More importantly, we hope that you and your families continue to stay safe and healthy during these challenging times. Thank you for your continued support as we look forward to 2021.
Regards,
Edge Wealth Management
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