Were the U.S. S&P 500 gains in 2020 really surprising and what can we expect for 2021?
U.S. Equity Markets
No! Dating back to 1928, the S&P 500 has risen by 22.6% during the years a U.S. recession has ended as was “likely” the case during 2020. We say “likely” because the official scorekeeper of business cycles, namely the National Bureau of Economic Research has not officially identified the end date of the current U.S. recession (as of the time of this writing) which they identified as beginning in Feb. 2020. However, many will agree that the recession probably ended in May or June 2020 as many economic indicators, e.g., U.S. employment reported sharp upturns. Against this backdrop, the reason for the muted 16.3% S&P 500 performance during 2020 could be attributed to outsized 33.9% downturn from Feb. 19, 2020 to March 23, 2020 that required lots of catching up, to recover such losses. Stated another way, the S&P 500 enjoyed a massive 67.9% gain from its low on March 23, 2020 through year-end. Our optimistic S&P 500 return expectations for 2021 our built on economic stimulus from the Federal Reserve and Fiscal policy that has occurred along with the successful rollout of multiple vaccines. If our base case scenario materializes, we expect U.S. equity markets will rise by a robust 15% return year in 2021.
Why did markets dip in 2020?
Our analysis reveals that throughout history, the length of time that U.S. equity markets decline during economic slumps is commensurate with the length of the ongoing recession. Given that the average length of a U.S. recession (since 1928) has averaged about 13 months – it is no wonder that U.S. equity markets have also declined for about 1.3 years during recessionary periods. So, with a recession in 2020 that may have lasted only about 3 to 4 months, it should come as no surprise to anyone that the dip in the S&P 500 index was short-lived and lasted only from Feb 2020 -March 2020 despite the fact that the U.S. suffered one of its most severe recessions since 1929!
Still, history reveals that when recessions come to an end, equity markets tend to recover like a coiled spring! By way of example, the S&P 500 index has risen by an average of 22.6% during the year a recession has ended followed by a more moderate average gain of 3.8% during the year after a recession has ended. However, when the S&P 500 generates a return below this outsized 22.6% (during the year when a recession ends), the equity market has often outperformed, its long-term annual historical average (from 1928-2019) of 7.7% during the following year.
Examples include: 1949 -1950 (+10.3 and 21.8%), 1970 -1971 (+0.1% and 10.8%) 1982-1983 (14.8% and 17.3%), respectively. In fact, even after the Global Financial Crisis, when markets delivered an above average return in the year the Recession ended (2009-10) – markets still outperformed the next year, (e.g., 23.5% and 12.8%)! The only exception to this pattern occurred from 2001-2002 (-13.0% and -23.4%) which one could attribute to fact that markets had to digest the dot.com bubble and the debilitating effects of 9/11. Given the tepid 14.6% YTD return in the S&P 500 index (through Dec. 24, 2020), our analysis strongly suggests that investors should expect at least a positive 10 to 15% during 2021.
On the other side of the coin, whenever the S&P 500 has generated positive returns in excess of 22.6% during the year when a recession has ended – the market has generally underperformed its long-term historical average, the year after the recession has ended. Examples include: 1933-34 (46.8% and -5.9%); 1938-39 (25.2% and -5.5%), 1945-1946 (30.7% and -11.9%); 1961-1962 (23.1% and -11.8%); 1991-1992 (26.3% and 4.5%). Exceptions to this pattern were few but did include: 1954-55 (45.0% and 26.4%); 1958-1959 (26.4% and 8.5%) and 1975-1976 (31.5% and 19.1%). Interestingly, the unexpected equity market outperformance during 1959 occurred after the U.S. successfully battled the Shanghai flu epidemic.
Summary and Equity Forecast for 2021:
In 2020, the U.S. economy suffered one of the deepest recessions since 1929 in 2020 as Covid-19 caused even more deaths than observed during 9/11. The big difference was a much larger policy response from both the Federal Reserve and the Federal Government (via fiscal policy). To be sure, we expect further additional stimulus from both the Fed and the Federal Government in 2021.
Still most will agree that in 2021, U.S. equity markets will remain heavily dependent on the successful rollout of several vaccines. If that happens, the historical relationship of a below average year in U.S. equity markets during the year a U.S. Recession has ended should lead to another great year for U.S. equity markets in 2021! Only if the U.S. vaccine program is unsuccessful should investors expect a below trend average return closer to 3.8% (normally observed during the year after a recession has ended) or anything close to the disastrous -23.4% decline we observed in 2002 after the end of the recession in 2001. Consequently, equity investors should a healthy 15% return during 2021!