For many, this will seem like a return to a pre-pandemic world. However, it is important for investors to recognize some differences from the financial environment at the end of 2019.
First, at the end of 2019, the national debt, (defined as federal government debt in the hands of the public) was $17.2 trillion, or roughly 80% of GDP. Just two years later, at the end of 2021, we expect this number to have grown to $24.0 trillion, or roughly 108% of GDP. This higher debt level implies higher taxes in the years to come and, to the extent that this includes higher taxes on corporate profits, interest, dividends and capital gains, this should be factored into long-term expectations of after-tax returns.
Second, the pandemic has left valuations much more stretched. At the end of 2019, the yield on a 10-year Treasury bond was 1.92% and has since fallen to 0.86%, well below the current rate of inflation. If yields stay at current levels, the return on fixed income investments over the next few years will be miserably low. If, as we expect, yields rise and bond prices fall, some of these returns could be negative. In addition, as of Friday, the forward P/E ratio on the S&P500 was roughly 21.6 times compared to an already somewhat lofty 18.2 times at end of last year. If, over the next five years, the P/E ratio just reverts to its level at the end of last year, then stock prices will have to grow 3.5% slower than earnings.
In short, while the economy should stage a strong rebound when a vaccine is distributed, investors should recognize the greater challenge of achieving strong long-term after-tax returns given the future prospect of higher taxes and the current reality of higher valuations.
Finally, it is important to note the global and cyclical impacts of an eventual rebound. The very good recent news on vaccines suggests that it will be possible to end the global pandemic, and not just the U.S. pandemic, over the next one to two years. For U.S. investors, this is an added reason to look at both emerging market equities and developed country equities outside the U.S. where valuations are a lot more reasonable. In addition, a cyclical rebound, with still very low short-term interest rates, should lead to a steepening yield curve, benefiting value stocks and particularly financial stocks.
It may take some months for the investment themes of the global recovery to play out, particularly given the increasingly grim news on current infections and fatalities around the world. However, for long-term investors, it is important be positioned appropriately to take advantage of this recovery today and to trust in the logic of the 2021 recovery rather than the sad emotion of this pandemic year of 2020.
David Kelly is chief global strategist at JPMorgan Funds.