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Financial Decoder Bonus: 2021 Market Outlook


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2021 Market Outlook

As 2020 draws to a close, what can investors expect from the markets in 2021?

In this year-end bonus episode, Schwab experts look ahead to consider what investors might expect in 2021.

First, Mark talks with Liz Ann Sonders, Schwab’s chief investment strategist. Liz Ann offers her perspective on the direction of the U.S. economy and stock market. Vaccines represent a light at the end of the tunnel, but Liz Ann cautions that we will enter 2021 still in the tunnel.

Next, Mark speaks with Kathy Jones, Schwab’s chief fixed income strategist. Kathy looks at what bond investors might expect from the Federal Reserve and fixed income assets in the new year.

Then, Jeffrey Kleintop —Schwab’s chief global investment strategist—joins the show and examines what 2021 might hold for the global economy and markets.

Finally, as a busy election season winds down, Mike Townsend, Schwab’s vice president of legislative and regulatory affairs, offers his outlook for what to expect in politics and policy next year.

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Financial Decoder is an original podcast from Charles Schwab.

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Click to show the transcript

MARK RIEPE: I’m Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It’s a show about financial decisions and the cognitive and emotional biases that can cloud our judgment.

Today’s episode is going to be a change of pace from what we normally do.

This episode won’t feature a deep dive into a particular financial decision and the biases that can trip us up when making that decision.

Instead, we’re going to have four of Schwab’s top experts give us their outlook for next year.

They’ve all been guests on the show before, so you’ll be hearing some familiar voices.

First, we’ll hear from Liz Ann Sonders. She’s Schwab’s chief investment strategist, and she’s going to give us her take on what to expect from U.S. stocks and the economy in 2021.

Liz Ann, Thanks for being here today. This has been a rough year for many people, but the markets have recovered from the lows we saw in March.

Instead of bombarding you with a bunch of questions, I’m just going to ask one big, broad question. What’s your outlook for 2021?

LIZ ANN SONDERS: Thanks, Mark. So let me just put the crisis in the right context here. It’s unique in so many ways, but I think by virtue of the lockdown that was mandated by the government during the worst part of the pandemic, what it created was this giant chasm in the economy that arguably we’re still trying to get across. About the only sort of being, I would say, that got to the other side has been the market. So the bull managed to get to the other side, but we still have a big chunk of the economy, a lot of Main Street, individuals, small businesses, that have not yet crossed the chasm. And I think the reason why the market so effectively got to the other side was because of the power, the scope, the speed of monetary policy. That was … if you think of the chasm as needing a bridge to get to the other side, monetary policy, representing one of those planks, arguably spanned the entire side. But in terms of getting the full economy, all of Main Street, unemployed individuals to the other side, there is still more work to be done.

Now, obviously in early November, we got what was the beginning of a string of very good news on the vaccine front. And back when we had the massive monetary stimulus, we also had what, hopefully, will go down in history as just round one of fiscal relief. And the combination of what was done back in the spring on the monetary and fiscal side was really extraordinary. But as we know now, we still haven’t gotten much of Main Street, much of the more beleaguered part of the economy to the other side of the chasm, and that’s why there’s so much focus on the need for another round of fiscal relief. So both in terms of the ultimate successfulness and efficacy of the vaccine, plus the need for more fiscal relief, we’re still sort of waiting for the rest of the economy to get to the other side.

You know, one of the popular things to do in this environment has been to define the crisis or define the recovery with a letter. The ideal scenario would be a complete V-shaped recovery. We have other letters that have been used to describe the recovery. I’ve been using a sort of series of rolling Ws, where you get these fits and starts in activity, which I think is still fairly accurate. There are, arguably, parts of the economy that are still somewhat L-shaped. They had the descent and they’ve really just done not much more than flatten out. But I think the best letter to describe the overall crisis from a snapshot perspective is the letter K. And I think we can visualize it with the stem of the K representing the collapse in the economy by virtue of the lockdown. Then as we come back up to about the halfway point, that is also reflective of much of the economy having recovered, maybe half to two-thirds of where we were pre-pandemic. And then this unbelievable divergence that we have seen across myriad metrics between the haves and the have-nots, the winners, the losers, depending on whether you’re looking at demographics, age, health conditions, the stock market, parts of the economy. And you can see it in so many areas where you have the haves and the have-nots.

And some of these divergences, I think, are likely to persist, whether it’s strength in residential investment versus the weakness in commercial real estate, the goods part of the economy versus the services part of the economy, the pandemic sort of winners in terms of what industries have done well, and those in the still more beleaguered parts of the economy. Even thinking about income level and the much greater ease with which those at higher income jobs can work from home versus lower income jobs, more in the services area where there isn’t that flexibility. And then even in the market, with the concentration, the dominance of the “big five” stocks, until recently, and the rest of the market. So some of these divergences, I think, will persist. Others will start to narrow. And, in fact, I’ll get to it in a minute, but I think the divergences within the stock market of just a small subset of winners and a tremendous amount of carnage underneath the surface, we’re already starting to see some convergence there. So that’s potentially good news.

I think there’s a lot of unique ways to gauge the economy in this unique period of time. We can still rely on traditional leading indicators like the Conference Board’s Leading Economic Index and some of its sub-components are still crucially important, like initial unemployment claims. But I also think we have to be a bit more creative in using some data points that are more reflective of the unique nature of this current crisis, higher-frequency leading indicators. In fact, the New York Fed created a brand-new index back in March that they call the Weekly Economic Index. And it’s, essentially, their take on classic leading indicators; however, they look at some higher-frequency data points and update it twice a week, so we have a little more in the moment, real-time gauge of economic activity. And similar to broader, more traditional economic metrics, like GDP or payrolls, this Weekly Economic Index shows what looks like a V-shaped recovery, but the reality is that we’ve only gotten back about two-thirds of the way to where we were pre-pandemic. And I think this is something we ought to continue to watch, in addition to a lot of the traditional leading indicators. Some other unique, more new indicators that I think help gauge where we are in this recovery would be things like mobility data, and OpenTable seated diners, and TSA traveler throughput, search activity. So we’re going to continue to keep an eye on those.

Now, in terms of specifics within various subsets of leading indicators, the labor market is always important, but I think there’s a couple of key labor market data points that are particularly important in 2021. And one of them is the differential between temporary unemployment and permanent job losses. Now, temporary unemployment has come down quite dramatically, reflecting that the bulk of payroll increases since the low in April have been a function of people getting their prior jobs back, which is great news. Unfortunately, we’ve seen a commensurate spike up in permanent job losses, and that tends to reflect the scarring of the severity of a crisis like this. And then there are leading indicators for permanent job losses going forward, somewhat, obviously, things like layoff announcements, bankruptcy filings. So I’d keep an eye on those, as well. And then another sort of aspect to the labor market data that I think we need to keep a close eye on is the duration of unemployment. Right now, it’s good news that the unemployment rate has ticked down to less than 7%, but about 60% of the unemployed have now been unemployed for more than 15 weeks, and about 37% have been unemployed for more than 27 weeks. Again, another indication of the scarring effect from the crisis that have longer term implications for the economy.

Now, I touched a moment ago on the stimulus, both on the monetary side and the fiscal side. As a result, it caused the money supply to increase by more than 25% on a year-over-year basis, which is unprecedented. It’s, obviously, so far, been more to the benefit of asset markets than it has to the real economy, but there’s been a lot of concern about whether all this stimulus will ultimately be inflationary. And our view is, not in the near term. Number one, the crisis itself is inherently dis-inflationary, but, in addition, all that liquidity that has been pumped into the system, there’s been very little velocity in that money supply, which simply measures whether that liquidity, that money, is getting out into the economy and picking up speed, getting reinvested, getting spent. And that money velocity is still quite low, and you don’t tend to see a major inflation problem without a pickup in velocity. So that’s something I’m keeping an eye on as we head into 2021.

Now, to tie the macro into the stock market, in conjunction with the compression in the economy, of course, we had significant earnings compression. We basically just finished reporting third-quarter earnings, which, just like second quarter, was much better than expected, although, clearly, still in negative territory in terms of year-over-year decline in earnings. Now, part of the reason for earnings being better than expected is that analysts set the bar so low. And that was largely due to the uncertain nature of this pandemic. When left to their own devices, analysts just erred on the side of cutting estimates to the bone. That was also in conjunction with a record number of companies that simply withdrew guidance to analysts.

So as we move into 2021, we are setting the stage for a significant improvement in earnings, maybe even more than what analysts are expecting right now. Certainly, once we get to the second quarter because, of course, math is such that we will be comparing earnings in the second quarter of 2021 to the second quarter of 2020, which was the significant part of the compression, so the year-over-year comparisons get quite easy. The rub, of course, is that valuations relative to those earnings are quite lofty right now. Depending on how you measure P/E—and there’s multiple sources for earnings—you’re somewhere in the low- to mid-20s in terms of the forward P/E for the S&P 500®, which is quite stretched historically. In fact, the last time we were somewhat persistently at a level similar to this was back in 2000, and that’s never a healthy comparison when we’re talking about the market and valuations. But if estimates for next year prove to be a bit low, and it turns out that earnings are able to exceed those fairly conservative estimates, then I think we start to chip away at the valuation problem.

But as I often say about valuation, we think of it as a fundamental metric, but the reality is it’s as much a sentiment indicator as anything else. When you get into a momentum-driven market, especially one with a lot of enthusiasm, maybe even some speculative fervor and euphoric hype, valuations either take a back seat, or investors just simply say, “I’m not going to worry about it.” And those are environments where you tend to get stretched valuations.

And as we close out 2020 and head into 2021, right now, I’d say sentiment in and of itself is one of the biggest risks for the markets. We saw an incredible amount of enthusiasm relative to the “big five” stocks. Up until early September, they had been the big market drivers. Then the enthusiasm had spread to other parts of the market as we’ve gone through these series of rotations, out of growth into value, away from large-cap, into small-cap, away from the stay-at-home stocks to parts of the market that hadn’t done as well. So these rotations have had different flavors, but along the way, as we’ve seen the market broaden out, which is a positive from a fundamental perspective, in conjunction with the initial positive vaccine news, sentiment, which had been only euphoric in certain parts of the market, like the options market back in the September timeframe, is now pretty much across the spectrum of sentiment indicators.

Behavioral measures of sentiment, like the put-call ratio, other positioning measures, attitudinal measures of sentiment, surveys like AAII that simply measures the bullishness or bearishness on the part of investors. And we’re now really at a state that one might define as euphoric. In and of itself, as I often say, that doesn’t mean the market is going to move in the opposite direction, but it does establish greater vulnerability to the extent there is a catalyst. And in the recent period, the last time we saw sentiment this elevated was late January/early February of 2020, at which point, of course, we got the mother of all catalysts, the virus, and set the stage for the bear market that we had. So I do think we need to be mindful of this euphoria. With the stock market’s better performance has come much more optimism, and, again, I think that establishes a bit of a risk.

So I wanted to end on that sentiment note. You know, I think the fundamentals looking ahead in 2021 are improving and look fairly healthy, but this euphoric sentiment is a concern in the near term, and it’s something that I think we need to keep a close eye on as we close out 2020 and head into 2021.

MARK: Thanks, Liz Ann. Really appreciate your insight.

LIZ ANN: Sure, Mark. Thanks so much.

MARK: Next up is Kathy Jones. Kathy is Schwab’s chief fixed income strategist. She’s going to provide the 2021 outlook for fixed income investors. Kathy, thanks for being here.

KATHY JONES: Thanks for having me, Mark.

MARK: Kathy, the returns to stocks grab most of the headlines, but 2020 was also quite a year in the bond market. What’s your outlook for bond investors?

KATHY: Returns for bond investors are likely to be very different in 2021 than they have been this year. 2020 returns have been driven by the drop in interest rates, which supported prices of long-term bonds, and the Fed’s aggressive additions of liquidity, which bolstered returns of lower-credit-quality bonds. As we look out to next year, there isn’t as much scope for interest rates to drop. And, in fact, we see the potential for bond yields to rise moderately as the economy recovers from the COVID crisis. There also isn’t as much room for the riskier sectors of the market—like, say, high-yield bonds—to appreciate because they’ve already moved so far. Consequently, the strategy that makes the most sense to us is to keep the average duration in a portfolio on the lower end of normal and the average credit quality on the higher side of normal.

Now, let me just walk through those two components of interest rate risk and credit risk.

On the interest rate side, we expect the Federal Reserve to hold short-term interest rates near zero for the next few years. That’s what they’ve indicated in their forecast, and it seems logical. The economy still has a lot of lost ground to recover. GDP growth has regained about two-thirds of what was lost in the pandemic, but that leaves a significant amount of excess capacity and very high unemployment. And those forces should keep inflation in check for at least a couple of years. Meanwhile, intermediate- and long-term bond yields are likely to rise in line with the economy’s recovery. By our estimate that could take the yield on 10-year Treasuries up to as high as 1.6%, which is about where the yield was prior to the onset of the crisis in March. We think a reasonable range to expect in 2021 is about 1% to about 1.6% for 10-year Treasuries.

Now for investors, we think that means keeping the average duration in a portfolio a bit below the normal target. In other words, if you have investors who try to use the Bloomberg Barclay’s Aggregate Bond Index as a benchmark, that duration is around 6½  years. An investor concerned about rising interest rates might want to reduce that to the 4- to 5-year region to mitigate the impact of rising interest rates.

Now, for credit quality, an investor may want to stay in the higher-rated bonds, whether it’s in the corporate bond market or the municipal bond market. With yields relative to Treasuries in the corporate bond market quite low, the risk-reward in the lower-rated bonds just doesn’t look that attractive. In the muni bond market, the pandemic has put a lot of stress on budgets for many state and local governments. So we would be focusing on higher-rated issuers.

Finally, I’ll just identify a few areas of opportunity in the fixed income markets. First, is emerging-market bonds. Now, we’ve been emphasizing our bias towards higher-rated bonds, but we do see value in emerging-market bonds for a small allocation to add some extra yield. Here’s a couple of reasons. The yields are still relatively attractive compared to Treasuries. A global economic recovery tends to benefit EM countries more than developed-market countries because they’re often much more oriented towards exports. So a growing global economy benefits the exporters. And, finally, the dollar is weakening, and that’s a trend we believe will continue in 2021.

Now, for investors looking to take a little less risk, we do have a suggestion there, and we would suggest considering taxable municipal bonds. Now, issuance has gone up over the last few years due to changes in the Tax Code, making it more attractive for municipalities to issue taxable bonds than tax-exempt bonds. In many cases, the after-tax yield is higher than the yield on corporate bonds of similar maturity, but the municipal bonds have higher credit quality. So for an investor in the right tax bracket, it’s possible to get a higher yield along with a higher credit quality.

So those are a couple of ideas we think will work in 2021. I think it’s going to be a fairly challenging year compared to last year, but we’re looking forward to making some progress.

MARK: Thanks for that outlook, Kathy. Interesting stuff.

KATHY: Thanks, Mark. Thanks for having me.

MARK: Now we’re joined by Jeffrey Kleintop. Jeff is Schwab’s chief global strategist, and he was a guest back on Season 6 Episode 2, where we discussed the home bias.

U.S. investors often forget how large the foreign markets are, so what do you expect to see in the non-U.S. markets in 2021?

JEFF: Sure, Mark. Thanks for having me. As 2020 draws to a close, global economic momentum is fading, with infection rates on the rise, governments responding with lockdowns in November, and few prospects for any new major near-term stimulus. However, the global economy has the potential to make a full recovery in 2021, rebounding from the 4.4% GDP decline in 2020 with growth of 5.2% in 2021, according to current estimates from the IMF. Next year we expect very easy monetary and fiscal policy combined with a vaccine rollout in the first half of the year to lead to a strong rise in economic and earnings growth. This 2021 backdrop may see the U.S. pass the baton of global growth leadership overseas, favoring international stocks and a broader overall market advance compared to 2020.

In our outlook last year, we noted how the global economy had slowed and was on the threshold of a recession. Pre-pandemic, in the fourth quarter of 2019, six of the Group of Seven economies (Canada, the U.K., Japan, Germany, France, and Italy) had reported close to zero or negative GDP growth. 2020 was vulnerable to becoming a year of global recession even with the smallest catalyst. Of course, the COVID-19 pandemic was a big catalyst, causing a deep global recession in 2020, and it’s likely that the path of the pandemic will define the recovery in 2021.

This year’s economic plunge and rebound was largely synchronous around the world, with the low point in April corresponding to the spread of COVID-19 infections worldwide and governments’ response of strict lockdown measures. Since midsummer, economic momentum in nearly every major economy stalled, after climbing much of the way back to pre-COVID-19 levels. Now, a second wave of restrictions in response to a resurgence of the virus is again weighing on economic growth.

New COVID-19 cases are on the rise to varying degrees in Asia, the Americas, and Europe. Asia hasn’t suffered a second round of widespread lockdowns, although targeted restrictions have been used to respond to localized eruptions of viral infection. Europe’s secondary outbreak is ahead of the U.S., with some countries’ economies already having gone through a second lockdown.

Although the term “lockdown” was used, compared with the restrictions imposed last spring, it’s really “lockdown-lite.” For instance, France imposed new restrictions for November and December, including a curfew and closure of non-essential retailers, but kept schools, churches, manufacturing businesses, and construction sites open. This stands in contrast to the first lockdown in the spring, when all these areas of the economy were closed. While reinstated restrictions are driving a double-dip in the economic data, they have not been stringent enough to trigger another recession and bear market.

We expect the current economic weakness to yield to much stronger growth as the lockdowns are relaxed, the weather gets warmer, and a COVID-19 vaccine becomes widely available. In addition to the economic and geopolitical risks that accompany any new year, there are heightened risks tied to COVID-19. It’s unclear how quickly vaccines can be produced and distributed. We don’t know to what degree the second wave of coronavirus cases and the reinstitution of lockdowns will weigh on the global economy in the near term. And health care systems in some areas may be at risk of being overwhelmed as they respond to an uptick in cases of the virus.

There are some key signs that let us know we are on the path to recovery that we’re hoping to see in the year ahead. These include:

  • A second wave of lockdowns ending this winter, having successfully contained infections with less economic impact than the first wave in April and March. So far that’s playing out, but there is more to go.
  • Second, vaccinations moving forward over the next few months with mass immunization of the general public to begin by spring.
  • And, third, a sharp rebound in economic activity in virus-depressed sectors, especially travel-related areas, as immunity builds up over the summer.

We’ll be on watch for any deviation from this path, since it may mean bad news for the markets. But if we see these signs, the economy and market may remain on the path to recovery despite some negative data points. For example, business failures and unemployment may be elevated for some time, as is often the case early in recoveries.

For years, economic and earnings growth in the United States has exceeded the rest of the world. This is expected to change in 2021. With U.S. growth of 3.1% well below growth in Canada, Germany, France, Italy, Spain, and the U.K. of around 5 to 7%, according to the latest GDP forecasts from the World Economic Outlook published by the IMF.

And that translates into faster earnings growth. The current consensus earnings-per-share growth forecast by Wall Street analysts for companies headquartered in each country reflects a 20% gain for the U.S. in 2021, compared with gains of 30% in Canada, 40% in Germany, 38% in the U.K., and more than 60% in France and Italy.

The relative growth rates at the start of this new economic cycle reflect a big change from the last cycle, when the U.S. led global economic and earnings growth.

A strong rebound in earnings-per-share growth can help ease concerns about stock market valuations, which have climbed this year as stock prices rebounded and earnings suffered. A strong recovery in earnings growth would mean that price-to-earnings ratios can move lower, even if stocks continue to post solid gains.

We believe the strong vaccine-led recovery in global growth aided by fiscal and monetary stimulus should favor stocks in general, especially economically sensitive stocks. Although global equity indixes are on track for gains in 2020, these gains have been narrowly concentrated in a relatively small group of stocks that have benefitted from COVID-19 and the related government restrictions. While improving in November and early December, cyclical stocks have generally moved sideways since June, leading us to believe that markets have not yet priced in a broad recovery.

This disconnect within the stock market is hiding what we believe could be a long-term shift favoring international stocks. We can look at what the average stock has done this year by using equal-weighted indexes, instead of using capitalization-weighted indexes that have been driven by a small number of stocks this year. In 2020, the average international stock has kept pace with and even slightly outperformed the average U.S. stock for the first time in years, signaling a potential change in leadership from the last cycle.

Now, this may be surprising to some. But new economic cycles come with new leadership. Market leadership tends to last for many years, even a decade, before reversing at the start of a new cycle. For example, after international stocks outperformed in the 1980s, the 1990 recession saw a shift to U.S. stock outperformance. The 2001 recession saw a switch back to international outperformance, before the ’08 recession flipped the switch again to U.S. outperformance. And now, the start of a new cycle may once again signal a switch to international stocks.

These changes in leadership result from both behavioral as well as fundamental factors. After a full cycle of outperformance, relative valuations and earnings expectations often get stretched and begin to reverse with the catalyst of a new cycle. These factors have aligned once again favoring international stocks. History tells us that valuation extremes alone are rarely the trigger for changes in market direction or leadership, but they do help to support a shift during a new market cycle.

So to sum it all up, we expect that a near-term economic double-dip for the global economy gives way to a vaccine-led broad recovery in 2021. Key signs to watch to stay on the path to recovery include the second wave of lockdowns ending successfully this winter, mass immunization beginning in the spring, and a sharp rebound in economic activity in virus-depressed sectors unfolding over the summer. The new economic cycle may come with new market leadership as non-U.S. economic and earnings growth exceed the U.S. for the first time in years, supporting relative outperformance by international stocks.

Last year, we talked about the coming end of the cycle and likely shift in leadership in the 2020 Global Outlook. As the new cycle gets underway in 2021, rebalancing portfolios, including rebalancing exposure to international stocks relative to U.S. capitalization-weighted benchmarks, is more important right now than at any other time in the past decade in making sure you stay on the path toward your long-term financial goals.

MARK: Let’s wrap up this episode with the view from Washington with Mike Townsend. Mike is Schwab’s chief Washington strategist.

Mike, Washington is going to look different in 2021 than it did in 2020. What can we expect that makes a difference for investors?

MIKE TOWNSEND: Sure, Mark. Thanks so much for having me. Before we look ahead, let’s begin by looking back at the election results. On the presidential race, Joe Biden ended up with 306 electoral votes, the exact number that Donald Trump won in 2016. While legal challenges are continuing, we don’t expect any change to the outcome. The Electoral College met on December 14, where the electors formally cast their ballots. On January 3, the new Congress will be sworn in, and then on January 6, that’s the date when the new Congress meets in a joint session to open the Electoral College ballots and ratify the results in anticipation of the January 20 inauguration of President-elect Joe Biden.

The other interesting aspects of the election, of course, are the battles for control of Congress. And one of the most unexpected outcomes of the election was the fact that Democrats lost seats in their House majority. Now, they did not lose the majority itself, but they will go into 2021 with one of the narrowest majorities in history. In fact, it will be the narrowest margin Democrats have had in the House since 1877, probably a margin of five seats. There are still two congressional races that are in dispute. One in Iowa, where the margin between the two candidates is an incredible six votes out of 394,000 cast, and one in upstate New York, where the margin is 12 votes. Both of those races are tied up in legal challenges, so it could be a bit more time before the exact count in the House is finalized, but the narrow margin in the House will be a headache in 2021 for House Speaker Nancy Pelosi, and it could give a very small band of high profile progressives in the House even more power. Their narrow margin will give that small group of progressives some leverage over Speaker Pelosi, and they may be able to push some of their agenda in order to secure their votes for certain legislation. So that’s going to be something to watch.

But, obviously, all attention is on the United States Senate, because we’re not done with the election there at this point. After the election, Republicans currently hold a 50 to 48 majority going into 2021. In the election, Republicans did succeed in flipping a Democrat-held seat in Alabama from blue to red, while Democrats succeeded in flipping Republican-held seats in Arizona and Colorado to Democrat control. But the major news of the Senate races was that closely contested races broke to Republican incumbents in states like Iowa, Maine, Montana, and North Carolina. So Joe Biden winning the presidency did not have the coattails that a lot of people anticipated, but the balance of power in the Senate will come down to a pair of runoff elections in Georgia on January 5 of 2021.

So how did we get here? Well, Georgia is unusual in that it is one of only two states, along with Louisiana, that has rules saying that if no candidate gets to 50% of the vote on Election Day, then the top two candidates go to a runoff. And the other unusual aspect of Georgia’s election is that both Senate seats were on the ballot at the same time due to one being a special election to fill the unexpired term of a senator who resigned at the end of 2019 due to health reasons. It’s an unprecedented situation, in which two runoffs in one state will determine which party controls the United States Senate. Democrats have to win both races to forge a 50-50 tie. And once Vice President-elect Kamala Harris takes office, she would break that tie, giving Democrats the narrowest possible majority in the U.S. Senate. Republicans, on the other hand, if they win even one of the two races, then they will have the majority.

Now, what to watch for and what to expect? Well, special elections are notoriously unpredictable. You never know who is going to turn out to vote on a random Tuesday in January. And this particular special election, it’s really unprecedented in terms of the national focus and the staggering amount of money that is flowing into the state for these final three or four weeks to get out the vote and for advertising. But the thing that’s really going to be hard to predict—and I think that makes polling really unreliable, maybe even more unreliable than we saw in this election—is who will actually vote if there’s no presidential race on the ballot. And this cuts both ways. Republicans are concerned that fans of Donald Trump won’t come out to vote in the Senate race, and Democrats are concerned that Democrats who were very energized about defeating Trump in November may not come out for the same reason. So without the president on the ballot, it’s all very unpredictable. Republicans generally, in Georgia, should be favored in these races. But the changing demographics in the state make these very, very close races—too close to call—and we’ll certainly be watching in early January.

Why does it all matter? Well, the differences in the policy agenda in terms of what is achievable for President-elect Joe Biden are enormous depending on the outcome here. If Democrats have the majority in the Senate, then President-elect Biden would have much more flexibility to pursue his policy agenda. However, the narrow margin that he would have if Democrats do win the majority, a 51-50 majority, would probably make most of the far-reaching proposals he talked about on the campaign trail impossible. Instead, the new president would have to push more centrist proposals in order to keep moderate Democrats onboard. On the other hand, if Republicans retain their majority, they would have the ability to block most of Joe Biden’s agenda. And we would see that starting right out of the gate, as Joe Biden tries to get his cabinet confirmed—and the Senate majority could make that very, very difficult.

Well, if we end up in a situation where we have a split Congress again, are there areas of possible compromise? I would certainly start by looking at an economic stimulus as the number one goal coming out of the inauguration. Whether or not we get a stimulus package before the end of 2020, I think further stimulus efforts are likely in the first quarter of 2021. Infrastructure spending is clearly another place where there’s likely to be bipartisan compromise in 2021. It’s probably the issue that has the most chance of success. Both Republicans and Democrats know that we need to spend a lot of money on roads, and bridges, and airports, and tunnels, and that sort of thing. These efforts also create jobs, and they create jobs that are outside, where it’s easier to keep social distance and avoid the spread of the virus. So I think there’s a good chance of infrastructure spending being one of the top priorities.

And then, finally, there’s a bipartisan retirement savings bill that has a lot of momentum heading into 2021. Among the changes in that bill are raising the required minimum distribution age to 75. The bill would also add a second level of catch-up contributions. Under current law, when you get to be 50 years old, you can contribute more to your retirement account. And the new proposal would add another step-up in contribution limits at 60 years old. There are also provisions in this bill that would help small businesses start a plan and make it easier for businesses of all sizes to sign up new employees to their retirement savings plan as soon as they are hired. So I think this retirement savings bill is something also to watch in 2021.

But what I think won’t happen is big tax increases. Really, no matter what happens in the Georgia runoff, I think some of the major tax ideas that Joe Biden talked about on the campaign trail are off the table. I would particularly think things like changes to the estate tax, or changes to how capital gains and dividends are taxed, have a very, very low chance of happening, even in a narrow Democratic majority.

And as we have seen over the last several presidencies, I expect in 2021 you’ll see a lot of executive orders. Executive orders are a way for the administration to get things done without having to go through a divided Congress. And I expect we’ll see executive orders undoing some of the Trump-era regulations—certainly around immigration, the environment, and perhaps energy. And I expect you’ll start to see those on day one.

Finally, I’ll end in a place that I know Liz Ann Sonders likes to talk about, which is the reality that Wall Street really doesn’t know care that much who’s in power in Washington. We took a look at how the market has reacted to different configurations in Washington, going all the way back to 1901. One of the most likely outcomes in 2021 is that we have a Democratic president with a split Congress. And when we look at how the market has performed under that configuration, we find that it has the best returns, a 10.4% annualized gain. Except it’s a really misleading statistic, because we have only had that configuration 3.3% of the time. That translates to once. One four-year period in the last 120 years in which we’ve had that particular political configuration in the nation’s capital. And that’s just not a statistically significant sample, obviously. But here’s what’s also interesting. The two most common outcomes in Washington are a Democratic president with a fully Democratic Congress or a Republican president with a fully Republican Congress. And the market performance in those two situations is essentially identical. An annualized gain of 7.2% under a Democratic Washington versus an annualized gain of 7.3% under an all-Republican Washington. It’s a great illustration of how Wall Street doesn’t really care that much about who’s in power in the nation’s capital.

Here’s another way to think about it. Using the Dow Jones Industrial Average, we found that if you had taken $10,000 in 1900 and invested it only when a Republican was in the White House, well, you would have about $98,000 today. And if you had invested it only when a Democrat was in the White House, well, you would have about $430,000 today. But if you had stayed invested the entire time, regardless of which party held the White House, you would have about $4.2 million today.

Well, there’s no question that the new president and the new Congress will be faced with huge challenges in 2021. And the market does care about things like economic stimulus initiatives and other policy proposals. But, over time, the market is relatively indifferent to the political battles that take place in the nation’s capital, and as investors, we should all keep that in mind.

MARK: Thanks, Mike. You’ve been especially busy these last few months so thanks for squeezing us in.

If you’d like to learn more about our outlook on the market for the coming year, check out our special collection of articles on the Insights tab of

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Thanks for listening to Financial Decoder in 2020. This is the last episode of the year and the last episode of Season 6.

Before I go, there are many people who make this show happen: Pete Knezevich, Deb Hinton-Brown, and Patrick Ricci—to name a few. But the king of them all is Matt Bucher. Thank you, all.

We’ll be back with new episodes in late January.

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