April 20, 2021

Investment Outlook Summary

In the incredibly complex COVID investing climate, our focal point has been the metrics fundamental to investing: earnings and valuation.

Our roadmap has been as follows. COVID leads economic growth, which drives earnings and dividends. Inflation, interest rates, and sentiment play a key role in valuation. While COVID remains a short-term wild card, and may temporarily slow the pace of recovery, the economy will continue to grow and adapt.

This economic backdrop will power further earnings growth in 2021. When the winter wave of COVID comes under control—whether by vaccine, restrictions, or naturally—earnings estimates will likely increase. The single largest influence on equity prices going forward will continue to be the path of the pandemic which is setting a speed limit on the economy. In the immediate future, COVID remains a grave concern. Nonetheless, with the very encouraging vaccine news, we expect the storm to quell. As it does, not only will earnings accelerate, but sentiment will improve.

With the election called for Joe Biden, political attention now shifts primarily to the Senate, where two seats will be contested in a runoff election, with party control at stake.

While the political landscape is not yet set in stone, election outcomes were more moderate than expected by either side and now moderation is likely the name of the game—markets greatly prefer moderation over uncertainty.

Moderation paired with efforts to stimulate the economy and job growth create a favorable scenario

Ultimately the outlook for next year of rising earnings estimates, improving sentiment, low interest rates, and rising valuations will continue to power stocks higher in coming months. At some point, markets will need to contend with longer term slow global growth trends.

Equities: As we look ahead to 2021, we see an economy that is on the mend and making progress against COVID. With the economy running at about 95% of 2019, and favorable tailwinds for growth, we expect 2021 earnings for the S&P 500 at a level comparable to 2019. This would put earnings around $155–165. Longer-term earnings growth is likely to resume at a level slightly below the long-term trend of 6%. Our expectation is 5%. This rate of earnings growth, paired with a dividend yield of around 2%, and an expectation for stable to rising valuation metrics, leads us to an expected return of 7.5% annualized over the next three years for U.S. equities.

Fixed Income: With rates near all-time lows and credit spreads fairly tight relative to the economic backdrop, we continue to advocate fixed income as a capital protection allocation, rather than a return-seeking allocation. We suggest shorter durations relative to benchmarks (taking less interest rate risk). As the economic backdrop improves, rates will likely drift a bit higher, though we do not anticipate sustained, elevated inflation. Yield curves will likely steepen some, as the economy improves. Security specific credit analysis will allow for careful risk taking within the municipal and corporate segment.

Alternatives: While alternatives are generally pricey and illiquid, we do see three specific allocations that can be beneficial in portfolios construction. Lower-risk allocations bring diversification to fixed income, hedged equity can allow for unconstrained security selection and private equity—both classic buyout style and higher risk growth/venture—can play a role for return seeking investors.

Investment Styles: Balance between value and growth is preferred, as value will benefit from an economy with accelerating growth as COVID improves, while growth will benefit against a secular trend of slow global growth. We continue to suggest allocations to small cap, expecting that improving economic conditions will eventually begin to close the valuation gap against large cap. Modest allocations outside the U.S. can bring diversification and similar valuation benefit. Each should be pursued through active management as security selection will be critical to achieving these benefits. Importantly, active re-balancing is incredibly valuable in this volatile environment as allocations may have shifted given wide performance disparity.

The Investment Policy & Strategy Group

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