2021 Investment Outlook: “US Resilient”

Strategic Framework: "U.S. Resilient"

• The 2021 investment outlook centers on three core pillars:
  • U.S. Preeminence: Contrary to "declinist" narratives during the global financial crisis and the 2020 pandemic, U.S. institutions (Congress, Senate, Presidency, rule of law) remain robust and capable of overcoming shocks.
  • Stay Invested: Clients are advised to maintain equity exposure rather than underweighting, citing the S&P 500's 609% total return (approx. 18% annualized) from March 2009 to end-2020.
  • Institutional Resilience: U.S. corporate management and economic institutions have demonstrated the ability to generate reasonable earnings despite pandemic disruptions.

2021 Equity Return Expectations (U.S.)

• Base Case (60% probability): 8% total return, composed of 6% price appreciation and 2% dividends.
• Upside Scenario (25% probability): 17–18% total return.
• Downside Scenario (15% probability): 17–18% decline.
• Goldman Sachs CIO David Koston holds a base case return of approximately 17%.

Global Asset Allocation and Regional Views

• U.S. vs. Developed Markets (Europe, UK, Japan):
  • Recommendation remains to keep the preponderance of assets in U.S. equities despite relative cheapness abroad.
  • Justification: U.S. companies have outperformed global counterparts in earnings per share growth by approximately 5% annually since 2007; in technology, the gap is roughly 10% annually.
• Emerging Markets:
  • China: Projected to be the sole major economy with 2020 positive GDP growth and a forecasted 10% GDP increase in 2021 relative to 2019 levels.
  • Other EMs: Expected to show mixed results; India recovering from 2020 lows; smaller economies vulnerable.
  • Risks: Lower per capita vaccination rates, access to lower-efficacy vaccines (e.g., from Russia/China), and lack of data on efficacy against new variants.

Fixed Income and Asset Class Strategy

• 60/40 Rule Re-evaluation: Traditional bond returns are expected to be negative or near-zero (10-year Treasury projected at -1% to -2%).
• Strategic Role of Bonds: High-quality U.S. fixed income is deemed the only reliable hedge against deflation, economic downdrafts, and exogenous shocks (e.g., cyberattacks, geopolitical tensions).
• Credit Opportunities:
  • Recommendation to take credit risk specifically via bank loans rather than high-yield securities.
  • Rationale: Bank loans have floating rates (LIBOR-linked), reducing interest rate sensitivity, and hold seniority in the capital structure, offering better risk-adjusted returns than high yield.
  • Emerging market local debt is noted but U.S. assets preferred due to lack of currency risk.

Valuation and Market Dynamics

• Valuation Context: While current equity valuations are above long-term averages (pre-1996), they are justified by a low and stable inflation environment and are not at "bubble" levels.
• Market Forward-Looking Nature: The S&P 500's 18% rise in 2020 occurred despite grim fundamentals (3.5% GDP contraction, 345,000 U.S. fatalities, 10–11 million unemployed), illustrating that markets price in recovery before data confirms it.
• Tactical vs. Strategic: Clients are encouraged to be tactical (e.g., rebalancing overweight positions post-rally) but advised against going underweight equities based on fears of future risks like variants or slower vaccine rollouts.

Key Risks and Uncertainties for 2021

• Downside Risks:
  • Vaccine Efficacy: Uncertainty regarding protection against new variants (UK, South Africa, Brazil) and booster shot requirements.
  • Geopolitics: Potential market tension arising from U.S.-China relations under a Biden administration.
  • Internal Instability: Cybersecurity threats (e.g., SolarWinds), and domestic polarization between political extremes.
• Upside Risks:
  • Fiscal Stimulus: Potential for stimulus packages larger than the anticipated $1 trillion.
  • Pent-up Demand: High U.S. savings rates (rising from 8% pre-pandemic to the "low teens") could drive higher-than-modeled consumer spending.

Investment Lessons from 2020

• Unpredictability of Shocks: Recessions are typically driven by observable factors (Fed tightening, imbalances); pandemics are exogenous shocks that cannot be anticipated or used to time the market.
• Market Humility: Facts on the ground do not always predict market reaction; investors must acknowledge forecasting limitations.
• Long-Term Convergence: Economic growth eventually drives earnings, which in turn drive equity prices; maintaining a long-term horizon is critical.