Of the many words that people have used to describe this year (some of which can’t be printed in this forum), the one that seems to be favored is “unprecedented.” I will readily admit that this word is overused, in the same way that Chris Traeger (played by Rob Lowe) of Parks and Recreation used the word “literally” in just about every episode. However, I think a case can be made that 2020 has been so unusual and unexpected that few other words capture its essence so well.
“Unprecedented” is one of those words like “unique” that it is rarely used correctly. To be unique is to be literally one-of-a-kind, but most people use the word a little more loosely to mean very distinctive or unusual. Similarly, unprecedented (without precedent) in the strictest sense means not having any historical analog or completely novel. (If you haven’t already guessed, yes, my mother was an English teacher.) In this sense, I would argue that the sum total of 2020’s events have made this year a truly unprecedented one.
Well-established trends can’t always be taken for granted
In 2020, many of the rules or heuristics that investors often rely on proved to be useless. For example, before the pandemic started to have an impact on our economy and society, we were in the late stages of the longest economic expansion our country has experienced. Granted, it was a relatively weak expansion in terms of cumulative GDP growth, but it persisted for more than 10 ½ years. As a consequence, the U.S. unemployment rate had dropped below 3.5%, levels we hadn’t seen since 19691. Most economists would predict that such tight labor conditions would lead to a robust increase in wages and, more broadly, higher inflation. However, while wage growth has gradually risen over the past few years, inflation has remained well below its long-term averages. This has puzzled economists up to and including the Chair of the Federal Reserve.
When equity market volatility hit during February and March, stocks fell at a rate we’ve never seen before, at least in the U.S. From the February 19 close through March 23, the S&P 500 Index dropped about 34%. We have experienced declines of that magnitude before, but never over such a brief period of just 23 trading days. The crash of 1987 represented a comparable decline, but that took place over roughly three months. Other bear market declines have typically happened over periods greater than a year.
Ordinarily, a severe bear market like this one would favor low-volatility defensive stocks. During volatile markets, investors normally seek out boring-but-safe companies in sectors such as utilities and consumer staples, or stocks in other sectors that tend to fluctuate less than the market as a whole. They would not be expected to turn towards growth-oriented sectors such as technology. However, that’s what we saw this year. In general, stocks characterized by growth or momentum tended to hold up better than those with value, quality, or low-volatility attributes.
Unprecedented events create remarkable responses
Shifting focus a bit, the governmental response to the COVID-19-driven recession was certainly without historic parallel. Actions taken by the Federal Reserve surpassed those that were implemented in response to the 2008 global financial crisis, and much of what the Fed put in place back then had never been tried before. This time around, the Fed’s balance sheet expanded by more than $3 trillion. These expanded bond-buying programs plus a number of newly-created credit facilities meant that the Fed’s level of support reached levels that were, you guessed it, unprecedented. The fiscal response was also dramatic. The U.S. Congress passed legislation to appropriate more than $2 trillion in funding for large and small businesses, enhanced unemployment benefits, direct payments to individuals, state and local governments, and the health system. It also seems likely that there will be additional funding appropriated in the future, even if we don’t yet know the amount or what specific forms it will take.
Given how oversold stocks became in late March, it was reasonable to expect that some sort of rally would occur off the market bottom. But did anyone really expect the magnitude of the recovery that we witnessed? The S&P 500 Index rose more than 65% between March 23 and December 1 (representing its all-time closing high as of this writing)2. This strength was at least partly attributable to the massive amount of monetary and fiscal firepower that was deployed, along with positive developments on the COVID-19 vaccine front. Still, the sharp rise in equities certainly raised the possibility that investors were pricing in a faster and more robust economic recovery than the fundamental economic data might have suggested.
One event that was seen as having the potential to reintroduce negative volatility was, of course, the election. In particular, many investors expressed concern about the possibility of a delayed outcome, since the unprecedented (sorry, I couldn’t resist) number of mail-in ballots would take time to count. Additionally, there was talk that the results might not be accepted by one of the candidates, which could result in recounts, court filings, or possibly civil unrest. As the old saying goes, markets hate uncertainty, and for a time it appeared that our system might experience a level of electoral uncertainty that we hadn’t seen at least since 2000.
Taking it all in a new, longer stride
So how did those predictions turn out? About as well as the optimism that Philadelphia Eagles fans (including me) felt at the beginning of this season. We did indeed see a delayed election verdict, as well as complaints about the integrity of the electoral process and calls for recounts and legal action. But equity markets didn’t seem particularly fazed. Since the election, any periods of weakness have so far been short-lived and appeared to be driven more by virus-related news than election issues.
I’m sure that there are other surprising aspects of this year that I haven’t even mentioned. All in all, I think it’s fair to say that the sum total of everything we witnessed this year (and it’s still not over!) has been unlike anything we’ve ever seen. I believe this is a point worth remembering in the future when we look back on 2020. After the hideous markets of 2008 and 2009, it was common for people to anchor their perceptions of what a bear market looked like on that period. I remember getting questions along the lines of “how should I position my portfolio for the next 2008?” Within this question was the implicit assumption that the next bear market would resemble 2008 and that any patterns or trends that we saw would likely be repeated.
This probably isn’t the right way to think about it. I would respond to those questions by pointing out that we weren’t likely to experience “another 2008.” The next bear market often looks very different from the last one, so rather than create a portfolio that would have held up well in that particular bear market, I considered it more helpful to consider a portfolio designed to be reasonably resilient no matter what the next bear market would look like.
Similarly, I can imagine some future time when an advisor (not wearing a facemask) asks me in person how to position a portfolio for “the next 2020.” I don’t expect the next bear market to look like 2020. It’s quite unusual (perhaps even unprecedented) to have a year when low unemployment doesn’t lead to inflation, markets drop dramatically in a very short period, growth stocks hold up better than most, trillions of dollars are thrown at the problem, the ensuing market rebound looks essentially parabolic, and even an atypical period of election uncertainty is greeted by the markets with a yawn. So if and when I do get that question, I’ll point to this blog post and remind them that just as 2020 looked very different from 2008, so the next challenging market will probably bear very little resemblance to 2020.
I appreciate that humans have a strong desire for certainty and predictability, and that we may derive some comfort from future turmoil if it has an element of familiarity to it. It’s natural for us to think that we can anticipate and prepare for an upcoming crisis even if we don’t know when it will occur. But it’s often unrealistic, simply because the future in unknowable. The next economic and market crisis, whenever it occurs, may resemble previous ones in some ways, but it will likely also have its own particular rhythm and lay out its own particular path of destruction. What worked in 2020 might not work next time. But so far, every bear market has been followed by a bull market, so I think it’s a pretty good bet that we’ll get through it, come out the other side, and enjoy a recovery. And hopefully when we do, the Eagles will be playing a lot better.
1 Source: U.S. Bureau of Labor Statistics
2 Source: FactSet, SEI
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Index returns are for illustrative purposes only and do not represent actual investment performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
S&P 500 Index: an unmanaged, market-weighted index that consists of 500 of the largest publicly-traded U.S. companies and is considered representative of the broad U.S. stock market.
Bear Market: a decline of at least 20% in a broad stock market index from its recent peak.
Momentum: Momentum refers to stocks whose prices are expected to keep moving in the same direction (either up or down) and are not likely to change direction in the short-term.
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