The market had a strong fourth quarter with the S&P 500 gaining 12 percent even as investors rotated away from the “big five” U.S. technology stocks that dominated performance through most of the year.  The market’s tendency to look forward outweighed the unfortunate surge in Covid-19 cases.  Investors saw better days ahead.

While Wall Street anticipated better days, the story was different for Main Street.  A legacy of 2020 was extreme inequality.  The rich got richer as stocks and home price soared, but the poor were hit the hardest and haven’t recovered.  This is why economists call this a “K” shaped recovery. 

The unemployment rate for Blacks is nearly double that of Whites.  Those without a school degree are unemployed at more than twice the race of those with a college degree.  Meanwhile, those making more than $60,000 a year saw more jobs in November than before the pandemic.  This type of inequality is unsustainable and often leads to social unrest. 

But there is light at the end of the tunnel.  When the virus fades later this year, people will be more comfortable resuming life the way it was, traveling, eating out, and spending money.  The economy will respond.  GDP growth in the fourth quarter is expected to be an annualized 8-11 percent and for all of this year 5 or 6 percent.  Those are very good numbers.   

The bull market has been relentless since the March low and shows no signs of topping out.  Investors are buying almost every day for the same reason, i.e. optimism that economic growth will accelerate as people are vaccinated and we return to the pre-Covid days of faster growth and better profits.  The recent relief package is also a tailwind.

The year ended with an upbeat outlook based as I've been saying in good part on the vaccine's impact on economic growth.  The only question is how much of this year's good economic news is already baked in the cake.  Quite a bit, I'm sure.  But even so, I can't help but come back to the fact that money has to go somewhere and the choices are few -- stocks, income vehicles, gold, Treasurys, cash.  Eliminate all but stocks and at times bonds and income vehicles such as preferreds. Stocks are still the place to be.

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.

Of course, there are stocks and there are stocks. I like what I like, own and recommend, and I frequently make my case for them.  But I watch a lot more for signs of excess in the stock and credit markets.  We are seeing a growing fascination with the riskiest stocks including new issues and special purpose acquisition companies (SPACs) that have yet to decide what business they'd like to be in. People are buying them anyway and IPOs of all kinds. That is not a good sign. We saw such buying leading up to the market peak in 2000 and at times in the 1960s and '70s.  In 1999 it was the dot-com mania. In the 1980s it was energy.  Now it's technology and electric vehicle plays.  Many will not survive. Reason for concern, if nothing else.

Whenever the market is trading at or near all-time highs, it's important to assess the risks. We are optimistic about getting to the other side of the Covid-19 chasm, but there are likely to remain some broken planks on the bridge to get there.  Few expect interest rates to increase much, which is why an unexpected rise might be the market’s greatest risk.  We’ll keep close watch.