We know now that as Wall Street analysts were publishing their 2020 forecasts the virus that would upend them all was already spreading in Wuhan, China. Jonathan Golub was particularly unlucky: On Jan. 21, Mr. Golub, Credit Suisse’s chief U.S. equity strategist, upgraded his prediction for the S&P 500 to end the year at 3600.
Discounting the threat of Covid-19 that day was an easy mistake to make, and one I made too. But imagine he had spotted the epidemiological consequences, and correctly recognized that the economy would plunge into the deepest recession in centuries. Surely no one would have concluded that his bullish S&P forecast was way too cautious, and the S&P would be more than 100 points higher than he expected by December?
“We thought there was no environment that could be worse than 2008-9,” Mr. Golub says. “This  made the Great Financial Crisis look like an appetizer. And yet the market did so well.”
Dozens of investors and bank strategists put out public prognostications for what would happen in the markets, but 2020’s combination was so unusual it was missed by everyone, so far as I can tell: a far weaker economy, far weaker earnings, but significantly higher stock prices, at least in the U.S.
By their nature, once-in-100-year events are hard to predict. But the real lesson of 2020 is that even correctly predicting fundamentals just isn’t enough. What mattered this year wasn’t earnings, but the speed and scale of the response by central banks and governments, alongside a recognition that the U.S. stock market doesn’t reflect the economy.
Much of the money poured into consumers’ pockets by Washington poured back out into savings—and the Federal Reserve’s extraordinary actions to push down interest rates and bond yields encouraged those savings into risky assets to find a return.
Money alone didn’t do it, though: The structure of the U.S. stock market was vital to this year’s performance. Technology and other disruptive growth stocks were the big winners from lower bond yields as so much of their profit lies far in the future; many were also boosted by lockdowns encouraging life to move online. Sectors vulnerable to the pandemic such as travel, leisure, oil and retail malls were crushed, despite the fiscal and monetary support.
If it was only about government aid, one would expect European markets to be boosted too. Yet despite even lower long-term bond yields than in the U.S. and plenty of fiscal spending, Britain’s FTSE 100 is down 11% this year in dollar terms, while France’s CAC 40 index is barely up. Both suffer from their paucity of exciting tech disrupters, unlike the S&P 500, up 15%, or the Nasdaq-100, up 46%.
Of course, telling a story after the fact is easy. Mr. Golub says for next time, investors need to realize that policy makers have learned from 2008 that it is best to come up with a quick and overwhelming response to a crisis.
“It means that in the future the downside risks around recessionary events are mitigated and that means the stock market should trade with a slightly higher multiple,” he says.
Another way to understand the weirdness of stocks being so expensive at a time when the economy is so weak is to consider the corporate bond market. Usually in a recession the Fed slashes interest rates and Treasury yields fall, but this is more than offset for junk bonds by investors demanding a fatter premium yield above Treasurys to cover the risk of default.
This year not only have Treasury yields fallen, but the risk premium—the spread over equivalent-maturity Treasurys—is down too. As a result, the yield on the junkiest CCC-rated bonds has fallen below 9%, well down from 11.8% at the start of the year.
The equivalent of this lower yield for stocks is a higher valuation. If you think one is overdone, the other probably is too.
Mr. Golub is concerned about short-term market excess, but his prediction is for the S&P to hit 4050 by the end of 2021 (others are more bullish, including
at 4300). The world will move to a post-Covid normal mid-cycle growth period, he predicts. Earnings will rise and valuation multiples will pull back.
The danger is that the bizarre year we have had leaves a legacy that prevents a normal recovery. There is a huge hangover of debt, deep uncertainty about how consumer and office-worker behavior might have changed, and many small businesses clinging on by their fingernails. The market doesn’t seem to be reflecting those risks in its valuation, because of the wild success of Big Tech and similar disruptive stocks. Fundamentals might matter next year, or it might again all be about fiscal and monetary support. Either way, it will almost certainly not turn out the way anyone is forecasting today.
Write to James Mackintosh at James.Mackintosh@wsj.com
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