UMB Financial : Great Expectations

In the fourth quarter there were great expectations. Great expectations that a COVID-19 vaccine will be readily distributed, great expectations that economic activity will improve as more businesses reopen and great expectations that more stimulus will boost consumption. In the 4th quarter of 2020, the market posted strong returns for both fixed income and risk-based assets and we expect that momentum to continue into 2021.

Economic Recovery

We saw a great recovery in the second half of 2020 and the economy remains firmly in recovery mode, driven by a massive amount of fiscal stimulus. Gross domestic product (GDP) was at an all-time high in the 4^th quarter of 2019 and fell around 10% from there in the 2^nd quarter of 2020. Since then, we recovered strongly over the 3^rd quarter of 2020 and believe we will have strong 4^th quarter 2020 numbers as well. There are three primary drivers that will continue the recovery in 2021:

1. An increase in discretionary income driven by the large amount of fiscal stimulus in the economy.
2. Growing consumer confidence as the labor market improves.
3. Reopening of the economy as the COVID-19 vaccine is distributed.

These drivers will help normalize economic activity. We are forecasting 4.7% GDP growth in 2021-the highest rate since 2000.

The Impact of COVID-19

Spiking COVID-19 cases and deaths have negatively impacted recent economic data. Soft employment data in December reflects the transitory impact of the pandemics latest violent wave.

High frequency data allows us to get a good sense of activity in real time. In the last few months, there has been a downward trend in mobility, such as traveling, retail traffic and open table seated diners, and we expect this to continue to be soft over the next few months. We are confident with vaccinations on the horizon these trends will increase throughout the year. Looking at personal income and the money supply, both have increased significantly with additional stimulus and we can expect an increase in spending.

Consumer Confidence

Consumer confidence did wane over the last few months as COVID-19 cases spiked. However, we can expect it to plateau-and like mobility trends-increase with the rollout and distribution of the vaccine.

The Role of Manufacturing

Manufacturing and services data are also leading indicators in economic stability. China has a healthy reading of 51.9 meaning manufacturing is growing at a modest rate. When we look at the U.S., the manufacturing purchasing mangers' index (PMI) is close to 61, which shows strong growth. Two components of this index are inventory and new orders. Due to the pandemic, manufacturing companies have had to do a significant amount of inventory restocking, ultimately increasing this number.

Expectations of a New Administration

We don't expect a change in administration to have a meaningful impact on the economy. However, President-elect Joe Biden has talked about issuing additional stimulus if needed. He has also discussed higher tax rates for both individuals and corporations. While no one likes to pay higher taxes, there's also talk about bringing back state and local deductions, which could balance those rates out. Changes in tax policy could also be delayed until 2022.

Even if we have a change in the corporate tax policy, stimulus, robust economic activity and increased consumption would still support corporate earnings. We don't the proposed changes in tax policy would derail the economic recovery and the performance of risk-based assets.

Financial Conditions Index

Favorable financial conditions, low interest rates and available credit, will continue to support the economy and markets. Historically, every time the financial condition index declines, it means conditions are improving, and as a result, the S&P 500 climbs as our economic conditions improve. Right now, we have very accommodative conditions, and the Federal Reserve has promised low interest rates for the foreseeable future which is good for economic activity.

Equity Markets

Financial conditions, economic reopening and stimulus are driving valuations higher. One of the factors we always consider is how expensive the market is. Right now, the market is trading at a premium and we believe valuations are elevated but sustainable for three reasons:

1. Financial conditions are accommodative with low interest rates.
2. COVID-19 vaccines will allow the economy to reopen.
3. Vast amounts of stimulus will boost consumption and corporate earnings.

Positive, But Below Average 2021 Return Forecast

We do expect positive returns in 2021 as we had around a 18% return in 2020. A common question we field is how stocks did so well last year when the economy struggled so badly. It comes back to financial conditions and what's driving valuations in the market higher. The markets have reacted to the great expectations we have of a COVID-19 vaccine as well as additional stimulus that will drive consumer spending and support the financial markets. Our forecast is between a 5-9% price return in 2021. So, while positive, it is below the 15% five-year average equity return.

Speculation & Risks

There certainly is a significant amount of speculation in the market right now and it's keeping valuations elevated. This year, we saw a significant increase of new online trading accounts, record flows into equity ETFs and record high margin debt. These trends can be a very significant risk for equities as money is often being made very easily with little consideration of how it can be lost easily as well.

For example, in 2020, we saw Tesla stock climb over 700% and Zoom stock climb over 400% so it's important to look back and see what typically happens the year after big companies make such large moves in the market. Looking back to 1999 with the tech bubble, the top-performing stocks were up 300-400%. One year later, they all came down 50% and a significant number of companies no longer existed three to five years later. The same story is true for 2007 when some of the big tech companies climbed up over 100% and the next year, their stock prices were cut in half.

The key takeaway is that you don't need every high-flyer to be successful. From 1999 to 2020, the S&P 500 gained 364% cumulatively.

Fixed Income and Inflation Expectations

There are two significant factors regarding fixed income and what will happen over the next few years - those are:

1. Inflation: With the amount of money printing, cash on the sidelines and stimulus coming our way, ultimately a push in inflation will happen. Inflation expectations have been rising since March 2020, but we believe we're probably two years away from inflation becoming an issue.
2. Interest rates: We've had a 40-year bull market with rates falling, which have pushed total rates of returns up. The returns that we've seen in the rearview mirror cannot be repeated because we are now near 0%. In 2020, interest rates fell 100 basis points when the COVID-19 crisis hit. With so much stimulus, we expect that interest rates will gradually rise. Looking forward, the outlook for the fixed income markets is 1-2% returns.

Conclusion

Even though we feel good about economic activity in 2021 and can expect positive rates of return in the equity markets, there are still risks. The largest risks are: the continuing spread of the coronavirus and a vaccine shortfall, the risk of inflation and speculation. We will continue to watch the risk of inflation which could change toward the end of the year due to additional stimulus. There is light at the end of the tunnel; However it's a long tunnel, and currently, we are still in it.

2020-2021 Forecast

Fundamentals of the U.S. Economy:

2018	2019	2020	2021
Real GDP	2.9%	2.3%	-3.5%	4.7%
Unemployment	3.9%	3.5%	6.7%	5.0%
Fed Funds	2.50%	1.75%	0.25%	0.25%
10-Year Treasury	2.69%	1.92%	1.00%	1.25%
S&P 500	2507	3231	3756	4100

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DISCLOSURE:

Statements in this report are based on the opinions of UMB Investment Management and the information available at the time it was published and are subject to change at any time without notice. This report is provided for informational purposes only and contains no investment advice or recommendations to buy or sell any specific securities.

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