Equity Investment Outlook: The Pandemic’s Long Tail

2021 was another strong year for stock market returns, with the S&P 500 gaining 29% after a rise of 18% in 2020. But the composition of returns across each year could not have been more different. 2020 was marked by a dramatic drop in corporate earnings and stock prices in the first quarter (when the pandemic started), and then a very strong rebound, largely concentrated in industries and companies that stood to gain from Covid-induced changes. This included e-commerce platforms and companies benefitting from the shift to work from home. Conversely, companies hurt by Covid, such as restaurants, hotels, and air travel got crushed.

Last year, by contrast, was more varied. For example, energy and financials rebounded strongly after a terrible 2020, while many tech companies that saw strong Covid-related gains in 2020 continued to surge in 2021. Investors were whipsawed by the re-opening of the economy one week and the spread of the Delta variant or the Omicron variant the next, in addition to news about vaccines and boosters. Underneath all this activity, a number of stocks fell noticeably below their highs, while an increasingly small number of richly valued tech names surged to new heights. In fact, only five such stocks accounted for some 30% of the S&P 500’s gains last year. Such concentration of performance is often viewed negatively by professional investors, but time will tell.

Now with 62% of Americans fully vaccinated and Omicron apparently highly transmissible, but not particularly lethal, we believe the economy will continue to recover. Consumers have lots of money and are growing tired of Covid restrictions. They are going out and spending and increasingly resuming normal activities. This should continue unless, of course, some new and more virulent Covid variant sends us all scurrying back into the safety of our homes.

As we survey the economic landscape, we think it only prudent to assess the impact of Covid and to sort out the temporary effects from the intermediate and permanent ones. We certainly would put the reduction of normal leisure and entertainment activities and product/commodity shortages in the temporary camp.

In the intermediate camp, we would note an acceleration in the move from brick and mortar retail to e-commerce, a shift from office to home for many workers, and an accelerated migration of the U.S. population to suburban areas, particularly to the sunbelt states. While not entirely new, these trends did gain considerable momentum as a result of Covid restrictions.

In the permanent camp, the most profound effect has been in the labor markets and supply chains. The pandemic has caused many older workers to accelerate their retirements, while it has caused many younger workers to stay home either to avoid catching Covid or to supervise children kept out of school. Many workers have also transitioned from one industry to another (e.g., from working in health care to working in warehouses), and workers have demanded higher wages, with labor strikes a common occurrence. As a result, labor participation rates have declined, and labor disruptions have become widespread. Couple this with the desire of companies to shorten supply lines – often by shifting away from offshore suppliers – and the result is a very tight labor market with upward pressure on wages as employers compete for scarce workers.