Predictions for investing in 2021 and how to cope
It’s almost over. The pain and agony of 2020 is almost behind us. There is a renewed level of optimism that the vaccines developed by Pfizer and Moderna can allow the world to return to a state of normalcy. As Americans push back on the latest round of lockdowns in states that are seeing dramatic spikes in Coronavirus cases, frontline workers are about to receive their first shots to prevent them from catching this deadly virus.
This is a reason to celebrate. However, the Federal government does not have a lot of experience in distribution and supply chain management. They have far more experience in red tape and non-sense bureaucracy.
Initial expectations have been set at June or July as the dates everyone who wants to receive their vaccination can receive that vaccination. My guess is that date is more like September of 2021. If I’m right, that will set a more pessimistic tone in the stock market.
Another important question is what will life look like post-COVID? Will companies keep all of their expensive office space, or will it be scaled back dramatically in favor of videoconferencing? Will business travel be cut way back in favor of videoconferencing? Will the hotel industry continue to suffer due to the reduction in business travel? My guess is ‘yes’ to all of these things and the changes will affect a lot of industries.
Many companies pay external salespeople a lot of money to live life on the road. That life is a lonely life and takes valuable time away from their family. However, many companies saw these same salespeople remain effective through the pandemic by videoconferencing. Management has taken notice of this and could very well allow this “hybrid” salesperson to spend most of their time at home and travel only occasionally. The good news is that the salesperson’s quality of life improved, but their compensation will most certainly collapse. This is just one example of the trickle-down effect of all of these potential cost saving changes corporate America will probably make.
Assuming we see a split government as a result of the Republicans winning the runoff election in Georgia (which I think will happen), then the stock market will view this in a favorable way. Typically, investors in the stock market despise dramatic changes in policy. They prefer the status quo. However, if the Democrats win the runoff election in Georgia in January, the stock market could take a significant tumble due to fears that the far left will drive higher taxes at the corporate and personal levels, increase capital gains taxes, increase regulations, and push initiatives that are anti-capitalist.
It is my firm belief that the first half of the year will show us a slower trajectory for the stock market, given the high valuation it has now versus the reality of a slow rollout of the Coronavirus vaccine. That said, once the vaccine does become widely available, investors should return to buying stocks aggressively given the inevitable increase in earnings by companies who have made all of these overhead reductions and the fact that there is no money to be made in bonds.
Even with the return of Janet Yellen, don’t expect any significant changes from the Federal Reserve in terms of interest rate hikes. The consequences of an interest rate hike go far beyond headwinds in the stock market. An increase in interest rates could significantly increase the interest payments on the massive amount of debt we have in the U.S. This would be politically unpopular and could cause even larger tax increases than what is planned by the incoming Biden administration. Look for a big rally in the stock market in the second half of the year.
Inflation is a consequence of easy monetary policy, rapid growth of the economy and dramatic increases in wages. It acts as a tax on our ability to buy goods and services. If it goes above the long-term averages for a long period of time (as Fed Chairman Powell suggested they would allow), this could force all of us to reconsider our existing financial plans and force us to save a lot more money (perhaps even millions more) for long-term funding purposes like retirement. Although I don’t see inflation as a threat in 2021, it could show up as early as 2022. Generally, the front of the inflation wave is fun! Full employment in a booming economy feels great! Rising wages occur due to the scarcity of talent and the need for rapid corporate growth. The stock market goes up and everyone is happy.
Then one day, the stock market flattens. The price of everything suddenly seems extremely high and the economy takes a dark turn. Companies start realizing they need to cut back on employees (because they cost too much and the company’s growth stalls.) Investors start realizing that the higher yields on newly issued bonds are more attractive than the risk they normally would take by owning stocks.
How do we prepare for inflation as investors? There is a growing camp that believes bitcoin could be a great asset for your inflation reserve. Their argument is around the idea that there is a finite amount of bitcoin, unlike gold which is labelled as scarce. These investors will also champion the benefits of blockchain technology and the rebellious streak against the world’s banking systems. There are a lot of logical arguments to be had around this topic, but when inflation becomes really bad, will investors act logically or emotionally? History tells us they will act emotionally and run to the asset that has been used for thousands of years to battle events like inflation: GOLD.
The financial services industry will continue to see consolidation among RIA (Registered Investment Advisor) firms due to the return of the fight over the Fiduciary Standard versus the Reg. Best Interest standard. The key difference is the fiduciary standard removes all conflicts of interest from investment advice (commissions). Assuming a fiduciary standard does take over the financial services industry, valuations of RIA firms could go even higher than they are right now and broker/dealer consolidation will happen at an increasing pace. Small broker/dealers will struggle to afford the level of compliance necessary to adapt to a fiduciary standard and many older advisors will use the event as a catalyst to exit the industry. Their sale to the large firms is inevitable. Only the largest remaining broker/dealer firms will have enough resources to adapt to this dramatic change.
Time will tell if the dramatic reduction in the number of competitors will have an adverse effect on the client experience. History tells us that competition is a good thing and it leaves me wondering what life will be like for both the advisor and the investor if only a handful of these very large firms survive.
All of these potential events might inspire investors to try to time their buy and sell orders according to my observations and predictions, but nobody can predict with any degree of accuracy how investors will behave from day to day, month to month, or even year to year. The best way to manage these potential challenges is to manage risk according to your unique timeline. Most financial plans suggest investors complete a “risk profile questionnaire” which serves as an indicator for their tolerance for downside risk. However, these documents are flawed due to the emotional nature of people.
I am a firm believer in a process called Dynamic Mapping which uses an “aging of portfolios” method of managing risk. This method looks similar to target-date investing but is more conservative. Target-date managers often assign a certain level of risk management benefit from the diversification of sub-asset classes, like small cap stocks vs. large cap stocks, and so on. The idea is that they can allocate more to stocks than the aging process due to the risk management achieved through diversification. However, during periods of extreme volatility, these sub-asset classes all correlate to ‘1’ (meaning they collapse at very similar rates). This is precisely the time when risk management is needed most. The aging process moves money gradually, on an annual basis from risk-oriented asset classes (stocks), to income producing asset classes, and then to highly liquid asset classes. Each portfolio is tied to the unique distribution date so that the investor never has to worry about the market crashing at a time when the money is needed most.
I am excited to see 2020 in the rear-view mirror. I am certainly more optimistic about our future. However, I do think there are challenges ahead and it would make sense for every one of us to think strategically about our risk management and how best to prepare for an ever-changing economic environment in America.
Jeff Mount is president of Real Intelligence LLC. Jeff has been active in the financial services business for the last 25 years.
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