By Keith Bonjour, Vice President, Portfolio Manager
The stock market continued to move higher, reaching new highs in the fourth quarter of 2020, with the election having a smaller impact on stock market returns than many anticipated. In 2020, markets proved how resilient they could be facing many risk factors throughout the year, but stocks were able to recover quickly after the COVID-19 induced sell-off and end the year on a high note. The S&P 500 was down 34% from mid-February towards the end of March only to end the year up over 16%. The bond market also had a strong year with interest rates and inflation both remaining at low levels. The Federal Reserve has continued to indicate that they will hold rates near zero for the foreseeable future, and that they will continue to keep monetary policy accommodative to help support the economic recovery. Congress recently passed another $900 billion stimulus measure after much political back and forth negotiations. This new package included $600 stimulus checks to every adult and child that qualified along with additional funds for small businesses struggling during the pandemic.
Looking ahead in 2021, the consensus view is that the stock market will continue to show positive returns with higher volatility along the way. The first half of the year will provide meaningful insights into how much further stimulus the government is willing to provide once Biden takes office. The additional stimulus measures along with a potential infrastructure package will need to be weighed against the increasing virus outbreak and the new virus strains from the UK and South Africa. Hopes are that the vaccine providers are able to ramp up production fast enough so that everyone that chooses to be vaccinated will be able to by the end of the second quarter this year. There have been several vaccines approved already with several more currently in late stage trials. Current projections are for a very strong recovery in GDP and company earnings in the second half of 2021, which has a lot to do with how well stocks have performed recently. The risk case is that if the vaccine distribution falls short or the vaccines do not prove as successful against the new strains of the virus, then this would cause economic growth not to rebound as quickly as projected, potentially weighing on stock prices.
Expectations are for both growth and inflation to increase this year with both showing stronger gains in the second half of the year. The Federal Reserve has indicated that they are comfortable letting inflation run higher than usual in this part of the economic cycle to help the economy recover. They also expect inflation expectations to come back down to around 2% after the initial surge. The risk case is that growth and inflation both overshoot to the upside, forcing the Federal Reserve to raise rates sooner than expected. This is currently a low probability, but does bear watching as we progress further into the year. Stocks and bonds are both trading at historically high levels, which puts pressure on company earnings to meet the elevated bar set for them this year.
We are continuing to be mindful of risks facing the market in 2021 as COVID-19 cases continue to surge, and stocks and bonds trade expensive compared to their historical averages. However, central banks and governments across the globe have provided massive amounts of stimulus that continue to help drive up asset prices. We continue to recommend staying the course with your investment objective and to continue to rebalance your portfolio by selling strengths and buying into weaknesses to adjust to movements in the market over time. We also recommend determining any short-term cash needs that you may have over the next six months. Creating this cash can help protect against an increase in volatility and short-term moves in the market. We recommend maintaining a more long-term focus on investment goals and objectives, and not reacting to short term up or down movements in the market.