The opening lines of Charles Dickens’s A Tale of Two Cities offer a fitting coda to 2020:

It was the best of times, it was the worst of times . . . it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair.

We’re left to contemplate the jaw-dropping list of extremes compiled during this turbulent year:

  • The coronavirus brought on the worst global pandemic in over a century.
  • In the U.S., more than 340,000 people died from Covid-19 – 85% of the number who died in battle in the four years of World War II.
  • In the second quarter, the U.S. experienced the worst quarterly drop in real GDP in 74 years of recorded quarterly history, an annualized decline of 32.9%.
  • But in the third quarter, it saw the biggest annualized gain in history: 33.4%.
  • Initial unemployment claims jumped from 251,000 to almost 3 million in a single week in March, crested at 6.2 million two weeks later, and remained above the pre-pandemic record of 695,000 every week for the remainder of the year.
  • Through bond buying, the Federal Reserve grew its portfolio by $2.7 trillion, or roughly 55%, and the U.S. Treasury funded roughly $4 trillion in grants and loans.
  • After the S&P 500 Index reached an all-time high of 3,386 on February 19, it fell 33.9% in just 32 days to 2,237 on March 23.
  • But from that low, the index regained the previous high in less than five months on August 18 (an increase of 51.5%). It ended 2020 up 67.9% from the low and up 18.4% overall for the year.
  • Unlike the credit crunches that accompanied many past crises, capital flowed like water. High yield bond issuance for the year was $450 billion, up 57% from 2019 and well above the prior record set in 2013. Investment grade debt issuance totaled $1.9 trillion, up a similar 58% from 2019 and also ahead of the previous record, set in 2017.
  • After the Fed cut its federal funds rate target to between zero and 0.25%, bond prices rose as bond yields fell in parallel. At year-end, the average A-rated bond yielded just 1.52%, and the average yield on high yield bonds (ex. energy) was just below 4%.

So we had a health emergency, an ailing economy, the most generous capital market of all time, and strong stock and bond markets. The seemingly anomalous relationship between the pandemic and recession on one hand and the strong capital and stock markets on the other can be explained by the Fed’s and the U.S. Treasury’s aggressive actions.

As suggested by the above catalog of events, the buying opportunity in 2020 turned out to be very brief, especially with regard to public securities and companies with the ability to access the capital markets. Defaults affected a large dollar amount of high yield debt securities, but default rates came nowhere near the highs that had been predicted and soon began to recede. Highly motivated selling was short-lived – essentially limited to the month of March – and we never saw the full-throated panic (accompanied by margin calls, meltdowns and forced selling) witnessed in prior crises. In just a few months:

  • investors grew confident about the inevitability of an economic recovery;
  • optimism developed regarding the outlook for a Covid-19 vaccine;
  • the near-zero fed funds rate brought down prospective returns all along the capital market line;
  • risk tolerance returned, and fear of missing out took over from fear of losing money;
  • asset prices rose, and the markets bounced back; and
  • the exceptional buying opportunity came to what for our purposes was a premature end.

Last year’s extreme, rapid-fire developments – and especially their origin in an exogenous and unforeseeable event, the virus outbreak – created great challenges for investors. To have taken maximum advantage, one would have had to have gone into late February prepared for a significant shock and then turned bullish a month later. Obviously, few investors did both.

Positioning for 2021

Because the market is at a possibly critical juncture and its direction is much debated these days, I’m going to spend an unusual amount of time discussing positioning going forward. Thus, you might end up feeling this memo should have been titled Preview of 2021 rather than 2020 in Review.