Huge Fourth Quarter Rally-A Prelude to Volatility?

Despite worsening COVID numbers and the uncertainty of a presidential election, stocks rallied massively in the fourth quarter. During the fourth quarter, the S&P 500 rallied 12.15% while the NASDAQ gained a strong 15.6%.  In a dramatic change from the last few years, smaller and mid-cap stocks represented by the Russell 2000 returned an astounding 31.4% for the quarter after having negative returns for the first nine months of 2020 and dramatically underperforming its larger counterparts. This is interesting in that the lockdowns have hurt smaller companies disproportionately than larger ones.  It is also interesting that while larger NASDAQ companies are firing on all cylinders, it is the stock of these largest companies like Amazon, Apple, and others that look tired and are losing momentum as we head into 2021.

While markets accepted the results of the Georgia run-off election and the Democratic sweep in an orderly fashion to date, there has been more money put into commodity based, industrial companies, and banks as investors are beginning to acknowledge the potential for higher rates and larger deficits. This rotation from previous outperforming industries like healthcare and tech happened quickly while the market has mostly traded within a range in the last week or so. As we approach fourth quarter earnings calls, it will be important for companies to understand how the economy will look over the next few quarters. There will be potential for increased volatility over the next quarter or two as we are reasonably certain that companies will show improved economic growth and earnings in 2021 compared to 2020. It is an open question whether many companies can return to 2019 levels of profitability.  How quickly the earnings come back may be further complicated due to issues involving the vaccine rollout and new congressional priorities.

Congressional priorities will have a major impact on how the stock and bond markets unfold in 2021. The Democratic party is made up of essentially two factions. It will be important to understand whether the traditional globalists as represented by Clinton/Obama old guard continue to dictate most policy decisions rather than the younger, more progressive wing of the party which would be far more focused on income redistribution through higher taxes and other means. Early signs are the administration will be made up primarily of Clinton and Obama holdovers and people who may be perceived as somewhat more business friendly than certain more progressive members of the party who are ideologically connected politicians like Bernie Sanders or Elizabeth Warren. For example, Biden appointed Boston Mayor, Marty Walsh, as Secretary of Labor despite Bernie Sanders interest in the job.  Thus, while initiatives like higher taxes and other progressive ideas will have a forum, it seems like further stimulus i.e. government spending will be the first outcome of the new Congress.

If Congress tries to revive the economy through stimulus and other pro-consumer measures, markets can continue to move forward. If the agenda shifts to higher taxes and income redistribution, markets will struggle to adjust. I suspect the first quarter could be calm but with fits of volatility until we can further discern domestic economic policy and its effect on this unique and unprecedented economy.  We maintain vigilance and, as always, please reach out with any questions or concerns during these difficult times.


Best to all-


Joe Ray