To say that 2020 was a year like no other would probably be a significant understatement. With COVID running riot across the globe, and political uncertainty in the US at an all-time high, global stock markets were subject to more than their usual dose of chaos and confusion.

 In the US, GDP growth plummeted by over 30% in the second quarter, only to rebound by a similar amount in the third quarter. Stock markets followed a broadly similar path with US equities witnessing their fastest ever decline, as they dipped by over 30%, before rallying by approximately the same percentage during the second quarter. For the year, results were sector dependent, with tech leading the way as the NASDAQ gained 43%, while the Dow grew by only 7%. Small company stocks, fueled by a year-end rally, gained 19%, and the S&P 500 grew by 16%.

In general, almost anything technology related soared, while the rest of the market struggled. Amazingly, by the end of 2020 the market capitalization of the FANGAM stocks (Facebook, Amazon, Netflix, Google, Apple and Microsoft) exceeded the combined value of all the rest of the world’s stock markets, with the exception of China. In the US, for the first nine months of 2020, these six companies alone counted for 77% of the gains achieved by the S&P—and the market cap of Apple, alone, exceeded that of the top 100 stocks in the UK.

 This imbalance was partly due to the fact that the US has a significantly higher percentage of growth and technology-oriented companies than the rest of the world. These companies benefitted from the impact of COVID as people worked from home and spent more time on social media. While increased earnings contributed to their performance, expansion in price to earnings ratios helped as well.

 Not surprisingly, given this dynamic, performance outside the US was less impressive, with the EAFE Index, (essentially the world excluding the US) gaining 5.4% in 2020. Regionally, Europe was up 3%, while the UK declined by 10% and Japan gained 16%. Emerging markets rose by 18%, largely driven by China, which now accounts for 40% of the index. On the fixed income side, the US bond market rose by over 7%. Commodities, led by rising oil prices, started to climb toward the end of the year. Precious metals also gained, with spot gold prices recording an increase of 24% for 2020.

Looking forward, the global economy is rife with challenges, though none loom so large as COVID, with its mirage like ability to stymie even our best scientists. Its unpredictable course makes it even more difficult to estimate the economic consequences, but for the moment the most likely outcome, (which we are using as our base scenario) is that the awkward beast will be mainly tamed by the second half of the year. Assuming that is the case, global growth should approach 4%, as the world economy, spurred on by a combination of monetary and fiscal stimulus, starts to recover.

The US, in particular, is benefitting from a huge injection of fiscal stimulus, with the cumulative impact of the various proposed support mechanisms potentially reaching 25% of GDP, in the event that the $1.9 trillion Biden relief package passes the Senate. This would still be a multiple of what most of the other major economies are doing. Under this assumption, US economic growth in 2021 may reach 6%.

On top of the potential fiscal impact, monetary policy in the US is also very expansionary. Between March and November of last year, broad money supply (M2) grew at its fastest rate in 150 years, with the somewhat narrower (M1) slightly behind. Certainly, one of the main propellants of the US stock market has been cheap money, and low interest rates. Together this has meant that there are few viable alternatives to stocks and that credit is freely available to buy stocks—or other assets.

In addition, primarily because of the virus, savings in the US have soared to record levels, with Americans having achieved saving rates upwards of 20% in 2020. If, and when, the pandemic ends, it is likely that there will be a lot of pent-up consumer demand with much of the money being spent on consumer goods and services like travel, restaurants, etc.

Taking all of these factors into account leads to several conclusions. First, the US economy is likely to be strong, particularly in the second half of the year. Secondly, inflationary pressures may start to build as a result of the combined effects of the stimulus noted above. While, short term, that could generate greater corporate profitability, over time it could also lead to higher interest rates, which would be a negative for both bonds and stocks.

Despite the fact that US debt, at 130% of GDP, has risen to levels not seen since WWII, the FED has remained relaxed about the potential inflationary consequences. In fairness, of course, inflation has been quiescent for most of the past decade, with most economists concerned about it being too low. At a recent seminar I attended with Chair Powell, he remained adamant about the FED’s intention to keep rates low, saying that it would be easier to control inflation on the upside than to prevent it from going too low. Nonetheless, I do not think the inflationary scenario outlined above can be entirely discounted. Regardless, with most classes of US stocks at, or near, all time peaks, I think the cautious stance we have taken in terms of allocation to US stocks is entirely justified, and we intend to maintain it.

With other major economies also pursuing stimulative policies (though generally less so than in the US), prospects for global economic growth are reasonably bright. Again, assuming COVID can be controlled, the potential for the first synchronized upwards movement in the world’s economies in many years is high. The consensus view is that global growth will be in the 4%-5% range for the year.

China was the only large economy to increase in size last year, with GDP up 2.3%. Expectations for 2021 are for growth to accelerate, with a gain of 6%, slightly lower than the 6.5% recorded in the fourth quarter of 2020. China also had a near record trade surplus of $535 billion in 2020 and led the world in terms of direct foreign investment, with inflows of over $150 billion. Aided by still favorable demographics (though this will change as the impact of the one child policy starts to make itself felt in the coming decade), and its ability to overcome COVID (so far), China’s growing stature as the primary engine of global expansion looks set to continue, as does the recent out performance of its equity markets. Consequently, we intend to continue our modest exposure to China and to selectively increase our allocation to other emerging markets, most of which have high growth prospects and are trading at a substantial discount relative to the US. Interestingly, we have already begun to see this valuation gap starting to close, with Asian stocks having gained 9% in January, versus a 2% increase in the US.

Like the emerging markets, the performance of European stocks has lagged the US for much of the last decade and as a result its markets now look sufficiently cheap to be enticing. With US price to earnings ratios at 22, which is well into the 90th percentile compared to historic valuations, the gap in valuations between Europe and the US is stretched. While partly explained by structural differences, as noted above, it has now reached levels where mean reversion appears likely to narrow the gap. Further, the dollar, which has been on a long-term roll, has started to weaken in recent months. This trend looks poised to continue, which would be another positive for non-US equities.

With average interest rates in negative territory, the historic dominance of bonds as the primary investment on the European continent may be waning, particularly given the gap in current income between bond yields and stock dividends, which now exceeds 3%. The partial resolution of Brexit should also alleviate some of the uncertainties surrounding trade flows in the region. Consequently, we intend to continue to gradually increase our weightings in Europe. As in the US, we are adopting a barbell approach, combining some risk averse, high dividend payers with a few growth oriented stocks.

Given the potential for interest rates to rise if inflation ticks up, bond markets will be vulnerable, especially at the longer end of the market. In the last eight months, we have already seen interest rates on the 10-year US Treasury bond almost double, albeit from a low level. We already have some inflation protected bonds in the portfolio, which have done well, and intend to increase those positions.

This macro picture, combined with high stock market prices globally, has led us to adopt a relatively defensive stance our core strategy, Global Growth. The current equity weighting of Global Growth is 60%, somewhat lower than its neutral position of 70% (NB these percentages are individually tailored for each client).

In an effort to balance risk and reward, we have adopted a barbell approach in the US, with a substantial weighting in defensive, value stocks such as Kinder Morgan and Iron Mountain, combined with growth-oriented positions in companies like Google and Uber.

We have followed a broadly similar approach in Europe including a mix of tech-oriented companies like Prosus and Roche, combined with more conservative stocks like Total and Telefonica which are paying current dividends of 7% and 13%, respectively. Approximately 14% of the portfolio is currently invested in Europe, and we have 6% invested in Japan. We continue to be overweight in emerging markets with approximately 10% exposure, primarily in North Asia.

Finally, we are well diversified by asset class, with fixed income securities, representing 20% of holdings. Roughly 10% is in short term US corporate bonds. In addition to several convertible positions, which had a great year, we have some limited exposure to preferred securities and floating rate instruments, both of which offer higher returns and some protection against inflation. Alternative strategies which are designed not to correlate with equity markets, account for the remaining 20% of our model portfolio. As regards the latter, the primary positions are gold (4%), inflation protected bonds, and hedged strategies, both of which are in the 5% range. Given our cautious outlook, I anticipate that we will maintain our weightings in this space, while adding some additional real assets like commodities and real estate.

In short, the portfolio is structured with an eye towards achieving a balanced position between risk and return. Given the high valuations of stock markets, particularly in the US, I believe the cautious, diversified stance we have adopted will serve us well in what is likely to be a tumultuous 2021.