Three Fed Takeaways from an Extraordinary Year

2020 was an extraordinary year for the Federal Reserve (Fed). The Fed responded swiftly and decisively to the rapidly accelerating financial and economic uncertainty brought on by efforts to contain the COVID-19 pandemic. The current Fed was helped by precedents and policies created during the 2008-09 recession, but also went beyond them to address the specific economic needs of the current crisis. We are not on the other side of that crisis yet, although we’re certainly getting closer, but there’s at least enough perspective to look back at what we learned about the Fed and markets in 2020 as we head into 2021

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A New Economic Start in 2021

After modest growth to begin 2020, the economy screeched to a halt as the onset of the pandemic ended the longest economic expansion ever. A record decline in gross domestic product (GDP) in the second quarter was followed by record GDP growth in the third quarter as the economy emerged from lockdowns. After such a tumultuous year in 2020, we take a look at what’s in store for the economy in 2021.

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Chart of the Year

Stocks continue to surprise to the upside, with the Russell 2000 Index (small caps) and the Nasdaq making new all-time highs on Tuesday. The S&P 500 Index, a chip shot from new highs, already has made 30 new highs so far this year. “One thing that surprises many investors is new highs happen in clusters that can last a decade or more,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Given that this cluster of new highs is only seven years old, history would suggest that we don’t bet against several more years of new highs.”

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Outlook 2021

LPL Financial Research Outlook 2021: Powering Forward

LPL Research Outlook 2021: Powering Forward is designed to help you navigate a year in which economic conditions may continue to improve dramatically. Like the markets, Outlook 2021 looks ahead.

2021 will bring advances to further limit the impact of COVID-19, and the goal remains keeping the economy as open as possible until then. Continued progress in the response to COVID-19, including further stimulus, will be key to sustaining the recovery. As the pandemic subsides, restrictions are lifted, and consumers’ daily lives return to something close to normal, the pace of the recovery should pick up speed—probably in the middle of 2021.

LPL Research’s Outlook 2021 covers post-election policy, the economy, stocks and bonds. Prepare to power forward in 2021 with the economic insights and market guidance in LPL Research Outlook 2021: Powering Forward.

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Stocks and Bonds Outlook for 2021

In Outlook 2021: Powering Forward, our 2021 year-end fair value target for the S&P 500 Index is 3,850–3,900, reflecting about an 8% total return from the close on December 11. Our target is based on a price-to-earnings (PE) ratio of around 20—slightly below current valuations—and our preliminary 2022 earnings per share (EPS) estimate of $190 [FIGURE 1].

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Is Inflation Looming?

The November reading for the Consumer Price Index (CPI), the most well-known measure of inflation, was released Thursday, December 10, and while both the headline and “core” readings (excluding food and energy) came in slightly higher than the Bloomberg-surveyed economists’ consensus, core inflation remains tame at 1.6% over the trailing year. Inflation is likely to pick up as the economy improves and may run a little hotter than we’ve seen in recent years in 2021, but we believe the risks of a substantial inflation surprise over the next year is limited.

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Beige Book Shows Rising COVID-19 Cases Affecting Regional Growth

COVID-19 cases have been on the rise in the US, particularly in the Midwest. This latest wave of the virus and related restrictions have begun to hamstring economic growth at a time when momentum was already fading as we entered the fourth quarter, based on the December iteration of the Federal Reserve (Fed)’s Beige Book.

In the Beige Book, the Fed presents qualitative observations made by community bankers and business owners—or “Main Street”—about economic (housing, labor market, manufacturing, nonresidential construction, prices, tourism, wages) and banking conditions (lending conditions, loan demand, loan quality). At LPL Research, we maintain an indicator called the Beige Book Barometer (BBB) to gauge Main Street’s sentiment by looking at how frequently key words and phrases appear in the text.

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