Fourth Quarter Review, Preview

For a large part of the year, the five largest stocks in the S&P 500 by market capitalization -- Apple, Microsoft, Amazon, Facebook and Alphabet/Google -- massively outperformed the other 495 stocks.  In early September, those five stocks represented nearly 25 percent of the S&P 500, so their hefty outperformance lifted the overall index.

In the fourth quarter market participation increased.  Small-cap stocks as measured by the Russell 2000 doubled the Nasdaq’s gain.  The market’s message points to a strong economic recovery.

There is another message from the stock market:  rates will remain low for years to come.  Fed chief Powell recently reiterated his plan to buy bonds and mortgages well into the future, at least until inflation rises above 2 percent and the expected GDP growth spurt appears. 

With interest rates at rock-bottom levels this continues to be a challenging time for investors seeking income.  Large-cap value indexes were about unchanged in 2020 and most investment-grade preferreds trade above par value with little room to move higher. 

An accelerating post-Covid economy represents the largest risk to fixed-income securities.  That, plus massive Treasury borrowing, would put upward pressure on interest rates.  Even a retreat to their par value would offset a good part of a year’s dividend payments.  From a valuation standpoint, dividend-paying stocks are more attractive than bonds. I still like some high yielding preferreds, though. 

Overall, expect some routine profit-taking from time to time, especially in the big-cap tech stocks that have extraordinary valuations. Profit-taking is one thing, a bear market is something else.  What could trigger that?  The prospect of a significant rise in inflation that is more than a temporary blip. We may see that by next summer and we'll see how income investors react.  So far, rising inflation is not on their radar.

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Disclaimer: David Vomund is an independent investment advisor. Information is found at vomundinvestments.com or by calling 775-832-8555. Clients hold ...

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Jaime Bond 1 month ago Member's comment

David, what are your views on the looming international debt situation as many nation states run dangerously close to default? While the US has the ability to weather the COVID storm, other countries will not have as much runway to economically meet their debt obligations. Since we still operate in a global economy, do you expect potential defaults to result in a different market forecast? What does history tell us?