Incredibly, in a year that saw so much devastation around the world, return numbers for most asset classes were not only positive, but in double-digit territory. US stocks recovered quickly after a catastrophic drop in March and are now once again on an upward trend. There remains, however, a sharp discrepancy between growth and value stocks. Small-cap stocks rallied in the fourth quarter, with news of the coronavirus vaccine.

Given the crippling effects of covid-19 on economies all over the world in 2020, one would expect to see negative stock-market returns in most countries. Happily, this was not the case. China and the US were able to recover from their early losses and ended the year with 20 per cent-plus returns. Much of Europe and South America was not so lucky. With vaccination programs now beginning in most countries, there is hope that the recovery will pick up in 2021.

1-Year Trailing Returns of Morningstar Country Indexes in Base Currency by Percentage

Source: Morningstar Country and Region Indexes. Forecasts from the European Commission and the International Monetary Fund. Data as of Dec. 31, 2020

A downturn, recession, and recovery—all in 2020

The covid-19 bear market saw US stocks drop by 19.6 per cent from January to March 2020. However, the 19.6 per cent is calculated using monthly returns. In terms of daily returns, the loss was 33.8 per cent (from the Feb. 19 peak to the March 23 trough). The market fully recovered these losses by July, technically marking the beginning of a new expansion only four months after the end of the downturn. With the exception of September and October, all monthly returns have been positive since.

US Market Downturns, Recoveries, and Expansions

Source: Stocks—Ibbotson Associates SBBI U.S. Large Stock Index. Recession data from the National Bureau of Economic Research (NBER). Data as of Dec. 31, 2020

Trailing-12-month performance of major asset classes

All major asset classes dropped in unison when the pandemic hit in March. A rapid recovery then began in late spring and continued throughout the rest of 2020, undeterred by the slight drop in September. This resilience was strongly sustained by expansionary monetary and fiscal policy, and fueled by optimism that economic activity would pick up once a vaccine became available. Concerns remain, however, that skyrocketing returns may have resulted in overvaluations.

Source: U.S. stocks—Morningstar U.S. Market Index. Developed-markets stocks ex-U.S.—Morningstar Developed Markets ex-U.S. Index. Emerging-markets stocks—Morningstar Emerging Markets Index. U.S. bonds—Morningstar Core Bond Index. Commodities—Morningstar Long-Only Commodity Index. Data as of Dec. 31, 2020

There has been significant performance disparity between sectors during the covid-19 crisis. In US markets, Technology and communications-services stocks were well-positioned to make the best out of a terrible situation, as stuck-at-home consumers ramped up their online shopping and tech device usage. Real estate and utilities ended the year in negative territory since offices and factories remained closed or running at limited capacity. Notably, some of these trends started to reverse in the fourth quarter.

US stock market’s price/earnings ratio returns to historical highs

The cyclically adjusted price/earnings (CAPE) ratio of the S&P 500, a way to assess whether the market is undervalued or overvalued, rose to 33 in December, eclipsing 2018 highs. When the ratio is high, stocks are expensive relative to their earnings, with periods of low long-term returns for the next decade usually following. Prior to 2018, the ratio surpassed 30 only twice in American history – the late 1920s, leading into the Great Depression, and the late 1990s, before the dot-com bubble burst.

S&P 500 CAPE Ratio

Source: Macrobond. Data as of Dec. 1, 2020.

Technology IPOs dominate like it’s 1999

US IPO activity gained momentum in 2020, with 325 companies going public versus 193 in 2019. Over the past five years, 26 per cent of IPOs have been in the technology sector, the largest share by market cap since the late 1990s tech boom, and 15 per cent in the communications services sector. This is a sharp uptick from the five-year period prior, when offerings were dominated by the consumer cyclical sector and only 20 per cent of offerings were attributed to technology and communications combined.

Source: Morningstar Direct. Data as of Dec. 31, 2020

Treasury curve steepens, reflecting an improved economic outlook

The Fed Funds Futures curve returned to solidly positive territory in late 2020 on an improved economic outlook. While the market is not pricing in a rate hike anytime soon, it has largely priced out the possibility of the Fed experimenting with a federal-funds rate below zero. As recently as July, the futures curve indicated potential negative rates by end-2021. Federal Reserve officials have stated multiple times that negative rates are not being considered as part of the policy toolkit.

The Treasury curve steepened significantly in the fourth quarter of 2020 as longer-term rates increased and the short end remained anchored by Fed policy expectations

(namely, to keep the federal-funds rate near zero for an extended period). This is certainly a positive signal that the bond market is pricing in a reflation of the US economy, but market pricing suggests longer-term nominal growth expectations remain suppressed: The 10-year yield remains roughly 100 basis points below its end-2019 level.

US Treasury Yield Curve

Source: U.S. Federal Reserve. 10-Year US Treasury Bonds—Bloomberg Barclays US Treasury 7-10 Year Bond Index. 20+ Year US Treasury Bonds— Bloomberg Barclays US Treasury 20+ Year Bond Index. US Corporate Bonds—Morningstar Corporate Bond Index. US High Yield Bonds— Bloomberg Barclays US Corporate High Yield Bond Index. USD EM Bonds—Morningstar EM Composite Bond Index. Local Currency EM Bonds— Bloomberg Barclays EM Local Currency Broad Bond Index. Yield curve data as of Dec. 31, 2020.