In our last client letter, 2021: Beyond COVID – Investing in the “New Normal,” we provided our outlook on the markets, the economy, and policies in 2021 that we expected would have the most significant impact on the investment decisions we make for your retirement portfolios.
Since that time, we have both a new administration and Congress that are finally working together to accelerate the pace of COVID vaccinations and provide stimulus support to those most in need. We all hope their success on both fronts will continue.
As we approach the anniversary date that most of us first heard about COVID-19, there are signs that the worst may finally be behind us. Late last year, Congress passed a large, $900 billion COVID relief package – followed more recently by a 2nd and even more extensive $1.9T fiscal stimulus program. The U.S. Federal Reserve, which reacted quickly to the initial economic fallout from the COVID crisis, continues to remain on hold. The most recent commentary from Fed Chairman, J Powell, highlighted that the Fed remains focused on promoting job growth and returning the U.S. economy to full employment – rather than controlling inflation. The Fed also recognized that the pandemic’s brunt was falling disproportionately on lower-wage workers and expanded its definition of ‘full’ employment to make it more inclusive. Central to that approach is a willingness to allow inflation to run higher than the Fed’s standard 2% goal for price stability.
It is no surprise then that with these two powerful forces now supporting the markets – monetary and fiscal policy – the most recent U.S. economic data are finally showing signs of improvement. The latest forecast for U.S. GDP growth for 2021 is between 3.5% to 4%, a rate that is close to the consensus forecast for emerging markets. Recent manufacturing data also indicates that a coordinated global recovery is underway, with growth in Asia leading other regions. Finally, corporate earnings have continued to exceed the most optimistic analysts’ forecasts. Earlier in 2020, during the midst of the worldwide COVID pandemic, the consensus estimate for Q4 corporate profits called for a decline of 10%. Actual Q4 2020 reported earnings for the largest U.S. companies increased by over 2% YoY – an improvement of nearly 12% compared with prior forecasts. (Source: LPL Financial Research, FactSet 02/26/21)
However, there still are troubling headwinds to this optimistic outlook. Small businesses, both here and abroad, have felt the brunt of COVID-related closures and travel restrictions. Also, many in our more socially and economically vulnerable populations have suffered disproportionately from the impact of COVID, widening the economic divide that existed before the pandemic. Perhaps no statistic highlights this effect more poignantly than the percentage of unemployed still classified as long-term jobless – those who have been without a job for more than six months. This number remains stubbornly close to 40%, almost a year after the start of the pandemic.
Despite this mixed data, we expect progress will continue to be made on vaccinating our more vulnerable populations, leading to an eventual reduction in COVID restrictions and setting the stage for a robust economic recovery. If recent history is any guide, we also expect that the markets will remain volatile. Negative news about the reduced efficacy of the current portfolio of approved COVID vaccines on new strains, a spike in infection rates, or even supply shortages could cause the market to retrace some of its gains since last April. However, we continue to believe that being diversified and remaining proactive is the best way to help our clients manage through this period of uncertainty.
As part of this diversification process, you may notice a few changes to your retirement portfolios in the coming weeks as we rebalance some of your existing investments that have out-performed and replace others that take advantage of future investment opportunities. Some of the changes to our clients’ fixed-income investments are in response to the historically low yields currently available on short-term and investment-grade bonds. As the economy continues to improve, we anticipate bond investors will demand higher interest rates to compensate for a rise in inflation expectations. Since bond prices tend to move in the opposite direction of rising interest rates, the value of certain types of fixed-income investments could be more negatively impacted by this trend. Over time, a rise in core inflation, which current Federal Reserve policy seems to support, could erode the future purchasing power of your retirement portfolios. Therefore, although we still prefer ‘quality’ over ‘yield,’ we are proactively adding to fixed income investments that are less impacted by rising interest rates (and future inflation), like floating rate, TIPS, and preferred bonds.
Similarly, when making changes to our clients’ retirement accounts’ equity investments, we will continue adding to our favorite long-term investment themes, namely Environmental, Social, and Governance (ESG). One of our preferred ESG investments is the Pax World mutual fund series offered by Impax Asset Management, a firm with a long-standing commitment to socially responsible investing. We also continue to favor investments with exposure to the rapidly growing base of consumers located in Asia. Our favorite mutual fund in this area remains the Matthews Asia Innovators Fund, whose top holdings include Bilibili – one of the leading mobile gaming and entertainment companies in Asia – and Taiwan Semiconductor – the world’s leading producer of integrated circuits and semiconductors.
Other investment areas we continue to overweight include companies that are part of the growing Financial Technology, or Fintech, revolution. Whatever becomes the ‘new’ normal after this pandemic is over will most certainly involve more cashless and, hopefully, more secure online financial transactions. Innovative companies like Square, PayPal, Intuit, Visa/Mastercard, and Fiserv will be leaders in this area. Equally important is our positive long-term investment outlook for the medical technology sector, particularly medical equipment and devices. We believe that demand for diagnostic testing, implantable and non-disposable medical devices will remain robust and perhaps even accelerate once the threat of COVID subsides.
We also wanted to inform you of other equity investments we have added that have exposure to innovative – some might even classify as disruptive – industries, such as genomics, robotics and artificial intelligence, cloud computing, and battery technology. We believe that the companies involved in these emerging industries will be long-term winners for our clients’ retirement portfolios.
Finally, we continue to favor alternative investments, like real estate and commodities, both for their diversification benefit and as a hedge against inflation. With regard to our real estate investments, we still prefer the mutual funds offered by the leading asset-based investment firm, Cohen & Steers, and their exposure to growing areas of the real estate market like public storage, data warehousing, and cell tower infrastructure. All of us at The Legacy Foundation hope that you, your family & loved ones remain safe and healthy during this challenging time. We also would like you to know that our team is available to answer all your financial and retirement planning questions.
Best Regards,
Marc Saurborn
Marc D. Saurborn, CFA, MBA, MScEng
Portfolio Manager & Chief Investment Officer
Judy L Esau, ChFC, AAMS
President
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