The Market Outlook is our annual tradition of sharing our expectations for economic growth and the performance of the financial markets in the year ahead. In any year, forecasting financial outcomes is a difficult proposition, but in this year of turmoil and uncertainty, it feels more daunting than ever before! But experience has taught us that the first step in attempting to discern what lies ahead should always be to closely examine the events of the recent past and assess the current financial landscape.
So, let’s begin there. Here is a snapshot of economic and market performance in recent years: 
The economic fundamentals in place from 2017-2019 were solid and consistent: Slow growth, low inflation, low unemployment, and low interest rates. Against this largely positive economic backdrop, the S&P 500 posted strong returns in 2017 and 2019, but a negative return in 2018. Consequently, last year we wrote:
"[t]he lesson here is that a good economic environment does not always guarantee positive equity returns.”
We entered 2020 on similar footing, anticipating slow economic growth, low inflation, low unemployment, and low interest rates. We also projected that U.S. companies would improve their earnings growth rate over 2019 (from 1.5 percent to between three and eight percent). If that came to pass, we figured it would be good news for the equity markets. Citing another excerpt from last year, we wrote:
"In this type of environment, stocks should have the wind at their backs during 2020. Of course, unexpected events can present themselves at any time, so there is no guarantee of positive returns. The one thing that seems certain is that market volatility will remain high."
Indeed, there was an unexpected event: A pandemic-induced economic recession that led directly to a severe, rapid bear market correction. While the pandemic could not be predicted, our anticipated catalysts, including impeachment proceedings, political skirmishes, Brexit, global trade conflicts, and a hyper-partisan presidential election contributed to market volatility. Collectively, we got the volatility we predicted and then some (and then more on top of that), but also still somehow managed to end the year with positive returns.
History was made last year in many respects.
- Longest Economic Expansion
The recession resulting from the pandemic ended the record-long period of economic expansion beginning in July 2009 and ending in February 2020. This expansion lasted 128 months, or 10 years and eight months! The U.S. economy expanded over 51 percent cumulatively during this time.
- Intentional Recession
This was the first U.S. recession that we intentionally entered. Recessions are normally caused by high interest rates, high inflation, over-leveraged U.S. companies and individuals, restrictive lending, and/or an overheating economy. This recession was caused by a national shelter-in-place practice that was instituted to protect the population from COVID-19 and to slow the spread of the virus so as not to overwhelm our medical system. In effect, we put the patient into a coma to protect the patient.
- Longest Bull Market
The pandemic-induced recession and subsequent bear market ended the longest bull market in U.S. history. This bull market began in March 2009 and officially ended in February 2020, lasting 132 months, or an even 11 years, and returned over 500 percent cumulatively.
- Shortest Bear Market
Ironically, following the longest economic expansion and bull market in modern history, the bear market we finally experienced last year (-34 percent) lasted just 33 days (2/19/2020 – 3/23/2020), officially becoming the shortest bear market in U.S. history. Compare that with the bear market ending in March 2009 (after the Great Financial Crisis), which lasted 517 days or 1.4 years. This was a very sharp and severe bear market, but the speed of the recovery was unprecedented.
Last year is not a year any of us would like to repeat. We lived through a pandemic, extreme volatility, a recession, and an ugly bear market. Yet, the S&P 500 Index ended up 16.26 percent for the year. I would propose that 2020 taught us this additional lesson: That a horrible economic environment does not always guarantee negative equity returns.
Comments on Our 2020 Estimates
Well, this section will be easy to write. The unanticipated pandemic, which preceded what will now be remembered as the Great Lockdown, played havoc with our 2020 estimates; it was an “all bets are off the table” situation for us in March 2020. As the table below clearly shows, we were way off the mark in all metrics except for inflation, which amounts to little more than a small comfort.
Inflation as of late (meaning the last decade) seems to be dead as an economic concept. The Fed has flooded our economic system with great levels of liquidity and yet inflation has remained well below their two percent target. With global economic activity down markedly due to the pandemic, it is hard to see a case where inflation returns meaningfully any time soon.
Looking Ahead to 2021
We began these Market Outlooks in 2017. Every year in early December, our team of investment professionals at First Command comes together to review economic data from multiple sources in order to prepare our estimates for the year ahead. As noted above, we sharply missed almost all our 2020 estimates. This was due to the unexpected and abrupt emergence of the COVID-19 “black swan” event – an unpleasant reminder to investors that low probability risks do not have probabilities of 0 percent. “Business expansions do not die of old age, they die for cause,” we wrote last year, which 2020 punctuated with multiple exclamation points!!!
Moving forward, the lack of certainty about our ultimate escape from the pandemic leads to a range of potential outcomes. Our base case, as outlined below, centers on the prospect for eventual containment of the virus and another leg up in the substantial economic rebound from 2020’s self-inflicted recession.
One way to extrapolate what went wrong last year into what we can expect next year is through the lens of famous English physicist and mathematician Isaac Newton, who theorized three laws of motion:
- An Object in Motion
The first law defines inertia, which states that an object in motion will remain in motion, exhibiting constant velocity, unless impacted by the action of another force. Last year at this time we predicted that “2020, from an economic standpoint, will look similar to 2019,” an extension of slow, albeit trend, activity supporting modestly higher stock prices and bond yields. However, the external force that changed that trajectory, in hindsight of course, was the pandemic.
- Change in Velocity
Newton’s second law attempts to estimate the change in velocity following the introduction of an external force by measuring that force’s momentum, or the product of its mass and acceleration. Heading into 2020, the U.S. was enjoying its longest expansion on record, supported by strong corporate profits and low interest rates. However, upon the realization of the severity and communicability of COVID-19, the global effort to contain it was unprecedented (mass) and swift (acceleration), which dramatically altered this otherwise steady economic trajectory.
- Equal and Opposite Reaction
Finally, and applicable to the second half of 2020 and extending into our outlook for 2021, Newton’s third law states that for every action in nature there is an equal and opposite reaction. Think of this as the snapping of a rubber band, wherein the further it is stretched, the harder it will snap back. After the devastating impact that the broader shutdowns inflicted on U.S. growth in the spring, the pivot toward reopening business activity in the summer brought the U.S. economy roaring back. Indeed, both the downturn and the reversal of activity were unparalleled in velocity, easily resulting in the sharpest moves in both directions (-31.4 percent and +33.1 percent in terms of annualized real GDP growth during the second and third quarters, respectively) in modern history.
Today, economic growth has continued to accelerate at a rapid pace, likely rising close to another 10 percent in the final quarter of 2020 based on early estimates from the Atlanta Fed. To be fair, there have been winners and losers in this evolving new paradigm, which we will expand on next in the unemployment section, and clearly the pace of this aggregate advance will have to moderate. But several tailwinds for the U.S. are likely to result in continued above average growth over the next year. The Center for Disease Control (CDC) estimates that the distribution of vaccines to prevent COVID-19 infection should increase substantially in 2021, which will help to support continued economic growth.  The Federal Reserve likewise has pledged to continue years of monetary accommodation, pegging interest rates at levels that are providing unprecedented support to businesses, consumers, and the equity markets.
The following sections reflect how we expect this base case to impact more specific areas of the markets and the economy.
Having plunged to a five-decade low around 3.5 percent just one short year ago, the unemployment rate spiked to a historic post-World War II high of almost 15 percent in mid-2020. Businesses downsized payrolls in order to survive the mandated shutdowns. This level easily surpassed the 9.9 percent peak following the Great Financial Crisis of 2008-2009.
Fortunately, unemployment also declined at a historic pace as businesses reopened. The recovery of the unemployment rate has a ways to go before reclaiming the pre-pandemic level enjoyed in 2019. On an absolute basis, the U.S. still needs need to add almost five million net jobs to reclaim such levels. The progress, unfortunately, will be much slower from here, which is evident through the timelier weekly initial jobless claims information (those continuing to file for new unemployment benefits) shown below.
Further, even within the group of more than twelve million workers that have been able to reclaim lost jobs, clear inequities exist. While higher earning workers – many of whom enjoy the luxury of being able to work from home or socially distance on site – have seen a swift rebound in employment, lower earning workers – many of whom are employed in service industries such as retail and restaurants – remain meaningfully impaired. Low-pay workers have experienced larger job losses as industries such as leisure and hospitality, personal care and traditional retail have been annihilated by the need for social distancing.
These inequities are borne out by digging a little deeper into the unemployment statistics. The unemployment rate for the top 20 percent of paying jobs is 2.9 percent, while the unemployment rate for the lowest 20 percent is 12.5 percent. Normally, a recession hits all workers across the pay spectrum more or less equally. This recession has hit the lower rungs of our economic ladder much harder than the upper rungs. The most economically vulnerable in our society are bearing the brunt of the pandemic and our efforts to mitigate its spread.
Clearly, we have work to do. Thankfully, the distribution of safe and effective vaccines promises to speed our progress. Consensus estimates for the national unemployment rate according to Bloomberg are for a gradual decline to six percent by the end of 2021 (from 6.7 percent today), and to five percent by the end of 2022.
Inflation and Interest rates
For years now, the Federal Reserve has maintained tight control over the short end of the curve via the target Federal Funds Rate. Following the Great Financial Crisis of 2008-2009, rates were pegged near their lower bound (0%) for the better part of a decade in the absence of any real evidence of inflationary pressures. Of course, stock investors reaped the benefits of “easy money” (the last bull market delivered 500 percent plus in stock returns), while savers have been forced to move outside of their comfort zones in order to generate any real income.
Alongside the increasing likelihood of tax reform following the 2016 presidential election, the Federal Reserve began normalizing interest rates as the business cycle matured. The Fed then reversed course on interest rates and brought them down to their lower bounds again in early 2020, as the pandemic reality set in. They have been there ever since.
We define the term lower bounds of interest rates in the U.S. as 0%, as domestic negative rates remain unlikely, having been consistently dismissed by monetary policy makers. Despite our overseas counterparts having experimented with negative interest rates in an attempt to force financial institutions to drain central bank reserves and extend credit into their economies, the Fed instead has chosen other tools to inject liquidity into the U.S. capital markets, and we would expect that trend to continue.
In fact, we anticipate that the Federal Reserve may be forced to act sooner than conventional wisdom may otherwise dictate. As government deficits have soared as a result of efforts to provide an alphabet soup of stimulus and liquidity to the economy, growth and demand have likewise surged from the depths of the early 2020 crisis. Spending, alternatively, held up better than even the most optimistic pundits likely would have estimated, but supply chain logistical issues resulting from ongoing rolling shutdowns have restrained capacity in many areas of the economy.
As a result, demand is proving less sensitive to rising prices than the unemployment rate would otherwise indicate, providing confidence for businesses to charge more in order to deliver resources that have suddenly become scarce (toilet paper, electronics, and even housing). Should growth continue to boom, we anticipate inflation to gradually follow, and perhaps finally pierce the two percent target range of central banks.
A common assertion by pundits since markets have soared to new heights is that stock prices have become disconnected from the economy. However, while imperfect, stock markets are forward-looking indicators, and thus have priced in not where we are today, but where we are likely headed post COVID-19. As such, while related, the stock market is not the economy, which is why, despite much progress still needing to be made on the economic front, stock markets have already roared to all-time highs.
Because equities are a perpetual investment, forecasting stock returns over any single period is always an imperfect science. The best we can do is attempt to compound our base case trend into a forward-looking outcome, understanding that there remains a wide range of potential outcomes. We often equate this to a meteorologist attempting to forecast where a hurricane will make landfall. There is a midpoint, but it has a large band around it, and it is subject to constant adjustment as new information rolls in.
Given our base expectation, we anticipate a slightly above average year in the stock markets, but perhaps with broader participation than we saw in 2020 (wherein U.S. technology focused companies with high market capitalizations were the primary benefactors). With the prospect for a gradual return to normalcy in the second half of 2021, supported largely through more widely available vaccines eventually suppressing the virus, forgotten areas of the market have an opportunity to catch up with the beneficiaries of the “stay at home” economy, which would tend to indicate a healthier overall market in general. Earnings estimates are steep, but realistic given the above, with the consensus forecast calling for over 20 percent earnings growth in 2021.
What does this mean to you?
First Command continuously assesses economic and market conditions. Currently, they look positive for 2021, as both the U.S. and the world continue to mend. But the path will not be linear, and things may get worse before they finally get better. Even with material progress on the vaccine front, a recent surge in new infections has begun to result in more localized shutdowns to contain further spread of the virus.
But we learned many lessons from the Great Lockdown, the most important being that there are simple, effective ways to mitigate the spread of the virus – such as mask wearing and social distancing – so that widespread lockdowns are not necessary. Ultimately, we will prevail, and when we do there is plentiful pent-up demand among consumers and businesses alike. Since our nation was formed, American ingenuity has overcome multiple tragedies, and after each crisis we have emerged better educated and equipped to tackle the next challenge.
Considering all this, we passionately believe that a well-designed, globally diversified portfolio that is aligned with your financial plan, investment time horizon, and risk tolerance is the very best approach to help you pursue your financial goals in uncertain markets. Please consult your First Command Financial Advisor if you have comments, questions, or concerns you wish to share. Thank you for the confidence you have placed in First Command.
The information in this report was prepared by John Weitzer, CFA, SVP, Chief Investment Officer of First Command and Matt Wiley, CFA, Director of Investments. Opinions represent First Command’s opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. First Command does not undertake to advise you of any change in its opinions or the information contained in this report. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.
All estimates provided are for informational purposes only and should not be relied on to make investment or other decisions. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.
The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. This world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 Index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. An investor cannot invest directly in an index.
The Dow Jones Industrial Average (DJIA) Index is a widely used gauge of the U.S. equities market with the longest history. The DJIA is a price-weighted stock market index that measures the stock performance of 30 large companies listed on stock exchanges in the United States. An investor cannot invest directly in an index.
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 Bloomberg (2021), Yardeni Research (2021). All 2020 data is based on the most publicly available information as of 12/31/2020.
 The recession induced by the COVID-19 pandemic was the shortest recession in U.S. history. Yardeni Research (2021).
 The unemployment rate spiked to around 15% during the height of the economic lockdown during the initial stages of the COVID-19 pandemic. It has since come down to 6.7%. Yardeni Research (2021).
 As measured by the 10-year U.S. Treasury note.
 Bloomberg (2021).
 Bloomberg (2021).
 In price only terms.
 The International Monetary Fund or IMF coined the term “The Great Lockdown” (World Economic Outlook, April 2020 : The Great Lockdown (imf.org)).
 A “black swan” event is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black swan events are characterized by their extreme rarity, severe impact, and the widespread insistence they were obvious in hindsight. See Black Swan Definition (investopedia.com).
 We state that the 2020 recession was self-induced because it was the first time in U.S. history that we intentionally put ourselves into recession. As a country, we decided to “shelter-in-place” to prevent our medical system here in the U.S. from becoming swamped from the COVID-19 pandemic. This severe lockdown basically shutdown economic commerce and sent us into a recession (contraction of economic activity).
 Bloomberg (2021) and First Command Investment Management Team. All 2020 data is based on the most publicly available information as of 12/31/2020. Forecasts are as of 1/5/2021. Forecasts are not guaranteed and are subject to change. Past performance is no guarantee of future results.
 Bloomberg (2021).
 Bloomberg (2021).
 New but narrow job pathways for America’s unemployed and low-wage workers (brookings.edu) (November 16, 2020).
 See page 4 of Our Favorite Charts of 2020 (wf.com)(data as of November 30, 2020).
 See page 4 of Our Favorite Charts of 2020 (wf.com)(data as of November 30, 2020).
 Bloomberg (2021).
 Bloomberg (2021).
 Yardeni Research (2021).
 Bloomberg (2021).