There is an old saying — “if you’re watching the train, then you’re not on it.” Hence, like a highspeed locomotive, stocks continue to rumble forward as we conclude the second month of the year with record highs recently established among most major equity indexes. Clearly, investors have been looking past various short-term uncertainties as optimism for the second half of the year is rising alongside upgraded expectations of improving economic and corporate earnings growth.
We find this to be a most interesting time, as we reach the one-year anniversary of the dramatic COVID-19-induced selloff (February 19–March 23, 2020), which resulted in history’s fastest 35% decline in the S&P 500® index, as well as a more than tripling of high-yield and investment-grade credit spreads.
We believe the risk of a meaningful pullback in stocks continues to increase. We define meaningful as being in the 5%–10% range between now and perhaps late spring when the favorable effects of second-half economic and earnings growth as well as improving virus trends driven by wider vaccine dissemination become more apparent. Perhaps investors will be content to wait out these next few months at increasingly higher price levels as these anticipated catalysts come to fruition. Then again, after experiencing a near double, perhaps not.
The markets are also in the process of absorbing higher long-term interest rates. Since the start of the year, the 10-year Treasury yield has seen a noticeable increase from 0.93% to 1.32% as of the close on February 16. When looking at the 10-year rate since last summer, the move is even more distinct from its early August closing record low of just 0.52%. While the reasoning behind this rise can be viewed somewhat favorably (strong anticipated economic growth in 2nd Half of 2021 and the implementation of higher-than-expected fiscal stimulus between now and that point), these higher rates could still create some short-term angst for investors given the higher price-earnings multiples now inherent in stock valuations. (The S&P 500 is trading at about 22x Current Year 2021 forward operating earnings estimates, according to FactSet Earnings Insight.)
We believe long-term investors should not be surprised in the event stocks experience a pull back or even a full-fledged correction of 10% or more. Based on the current market environment, should we see this type of downside activity, we believe it would likely represent buying opportunities as longer-term catalysts likely display increasing strength during the 2nd Half of 2021. Here we would focus on the following:
- Vaccine distribution is beginning to ramp up. Following a slow start in the aftermath of Pfizer’s and Moderna’s two-dose vaccine approvals toward the end of last year, we are now seeing the numbers of those vaccinated increasing at more rapid rates. In the U.S. as of February 16, more than 54 million people had received at least one vaccine dose with administration averaging more than 1.6 million shots daily. According to the calculation site worldometers.info, we are also finally beginning to see a decline in active COVID-19 cases — those patients who have contracted the virus but have yet to recover — as reported for the first time since September. These numbers could see further improvement in the months ahead as Johnson & Johnson was recently awarded FDA approval on its one-dose vaccine.
- High-dollar fiscal stimulus could soon be passed by Congress. Through budget reconciliation, it now appears President Biden’s $1.9 trillion fiscal stimulus package could pass the Senate with a simple majority. Leaving some room for negotiations within the Democratic Party, it is likely the legislation will pass with ultimate economic relief north of $1.5 trillion, considerably higher than originally anticipated. The composition of this stimulus, which is expected to include direct payments to individuals and families, assistance to state governments and small businesses, as well as more investment channeled into the national vaccine rollout, should help bridge the gap between current economic conditions and a strong second half acceleration.
- Monetary policy from the Federal Reserve looks to remain extremely accommodative. In his “State of the U.S. Labor Market” address on February 10, Fed Chairman Jay Powell was not shy to reiterate the committee’s short-term concerns about the economy, as reflected by slowing monthly job growth over the past several months. In this commentary, Chairman Powell further reiterated the Fed’s intentions to maintain the Fed Funds rate at a lower bound of zero and monthly open-market bond purchases of $120 billion. We view this ongoing monetary policy by the Fed as advantageous to the markets, particularly as the economy looks to improve in the 2nd Half of 2021.
- Corporate earnings growth forecasts are also rising. As the final wave of earnings reports for 4th Quarter 2020 now head into the history books, it appears the year will not conclude nearly as bad as most had feared several months ago. As gathered by FactSet Earnings Insight, Current Year 2020 operating earnings for S&P 500 underlying companies are now expected to finish the year only about 11% lower than 2019, less than half the rate of decline forecast last summer. Moreover, aggregate earnings forecasts for CY21 have now reached expectations of better than 23% growth, which if achieved would be close to 10% higher than pre-COVID-19 2019 earnings. When we combine stronger economic growth, fiscal stimulus, continued Fed open-market activity, and a rising vaccination pace, we see a high probability the market will be quite receptive to these potentially higher levels of earnings.
- Change of leadership toward value stocks is likely. As we have stated in previous commentaries, after a decade of lagging performance by value stocks relative to their growth counterparts, we believe the year ahead could see a meaningful reversal in that trend. Catalysts for value stocks in the 2nd Half of 2021 would include a general rising tide of economic growth, a steepening yield curve beneficial for large financial stocks, and changes in consumer behavior induced by wider vaccine distribution (also more favorable for much of the value universe).
Where does this leave us in terms of the high-speed market train investors still find themselves on? Perhaps this can be best answered from the differing perspectives of those on it and those who may feel they missed it. If we do see a market pullback or correction, passengers should probably realize they have come very far very fast and avoid temptation to disembark. Those who may have sold following last year’s decline and have not returned in the months since may perhaps recognize a second chance could be at hand and consider reboarding. While there could be some bumps on the tracks immediately ahead, it appears as though the next couple of years could potentially still be quite a nice ride.
By Tom Wald, CFA®, Chief Investment Officer, Transamerica Asset Management, Inc. February 17, 2021
Dreading Your Pandemic Tax Return? Answers to Your Most-Asked Tax Questions for 2020.
If you are confused about how the pandemic affected your 2020 taxes, you are not alone. Tax experts are still navigating the implications of the Cares Act, the Families First Coronavirus Response Act, and the Consolidated Appropriations Act of 2021. Businesses received some brand-new breaks and programs, such as the employee retention credit and the Paycheck Protection Program. Individuals received a hodgepodge of deductions, credits, and other breaks that are dependent on an array of information.
What is more, Covid-19 is still causing delays within the Internal Revenue Service, including their live phone support, processing paper tax returns, answering mail from taxpayers, and reviewing tax returns.
To bring a little ease to a tough topic during a tough time, here are some answers to common questions:
When is this year’s tax deadline? Will it be extended like last year?
This year’s deadline is Thursday, April 15, and it won’t be extended, even though the IRS, which usually starts accepting returns in mid-January, started taking them on Feb. 12. If you need more time to file, you can request an extension until Oct. 15. If you expect to owe money, you must pay an estimated amount by April 15. The six-month extension request is Form 4868 for individuals, and Form 7004 for businesses, and you don’t need a reason; you just need to request it.
Will I owe tax on the stimulus check I received last year?
No. The economic impact payments, better known as stimulus checks, were a tax credit for your 2020 taxes. For them to have an immediate economic impact, the government decided to send these checks as an advance on the 2020 tax credit. To do so, eligibility was based on income reported on the most recent tax return the IRS had. A second round of smaller stimulus payments–generally half of what was given in the Cares Act–was paid out in December.
They do need to be reported on this year’s taxes, though. The 1040 form has a new entry, line 30, “Recovery Rebate Credit” that must be filled out. Because much of the money was sent early in 2020, there are people who saw their income drop later in the year. If you were not eligible for the stimulus checks based on your 2019 return but would be based on your 2020 earnings, you can still claim the credit. If the reverse is true, and you received the money, but it turns out you earned too much in 2020 to be eligible, you will not be asked to return any money you received.
What if I was unemployed in 2020? How does unemployment affect my taxes?
Unemployment payments are taxable. When you applied for unemployment benefits, you had the option of having taxes taken out, but if you did not do that, you will owe federal and state taxes on your unemployment income. You will get a tax form, a 1099-G, that will include how much you were paid and how much tax was withheld. One thing to be aware of is that there have been problems with fraud this past year. Some people have discovered that scammers used their identities to claim unemployment checks they were not entitled to. If you receive a Form 1099-G for unemployment benefits you didn’t claim, you’ll have to contact your state unemployment agency to clear up the issues around that identity fraud before filing your taxes.
If I worked from home in 2020, can I claim deductions for my home office costs?
If you worked from home because of stay-at-home orders, you cannot deduct those unreimbursed expenses for your home office, because the Tax Cuts and Jobs Act eliminated those deductions through 2025. Instead, ask your employer if they will reimburse expenses for home-office setups or supplies. Those who are self-employed can deduct their home office and business expenses as they would normally do.
I home schooled my children last year. Can I claim an educators’ deduction?
Probably not. The $250 educator deduction is for unreimbursed expenses such as books, professional development courses, and other classroom expenses. This year, it also includes the cost of personal protective equipment, disinfectant, and other items to prevent the spread of coronavirus, bought on or after March 12.
Did You Know:
AS LONG AS RATES STAY LOW
– The average interest rate that the US government pays on its interest-bearing debt as of 12/31/20 was 1.695%, down from 2.331% as of 12/31/15. That means our government can borrow 37.5% more money today than it borrowed 5 years ago and still have the same out-of-pocket interest expense cost (source: Treasury Department).
RELIEF DOLLARS
– 36% of stimulus payment money received by Americans from the March 2020 CARES Act was put into savings, while 35% was used to pay down debt (source: Federal Reserve Bank of New York).
Quotes:
“For I know the plans I have for you,” declares the LORD, “plans to prosper you and not to harm you, plans to give you hope and a future.” – Jeremiah 29:11
“The future belongs to those who believe in the beauty of their dreams.” – Franklin D. Roosevelt
