January 2021
2021: A Quest for Clarity Amid Confusion

News of effective coronavirus vaccines may have felt like a light at the end of the tunnel as a tumultuous 2020 came to a close. While it’s reasonable to remain optimistic that vaccines will ultimately put an end to the pandemic, there is much less of a cohesive outlook on the investment side, leaving investors to ask several key questions:

  • Are stocks cheap or expensive?
  • Is it finally time for the value rotation?
  • Can the small cap rally persist?

In this 2021 Market Outlook, we’ll take you through the data, which we believe may provide clarity and reveal opportunities for 2021. Specifically, we’ll discuss:

  • Dividend growth
  • Thematic growth
  • Mid- and small-cap stocks
  • Corporate bonds
Are Stocks Cheap or Expensive?

It’s been repeated ad nauseam, but the chart below shows that it has historically been true: Low interest rates support higher valuations.

Historical Interest Rates Versus Price-to-Earnings Ratio

Source: Bloomberg. Trendline established based on historical relationship between PE ratios and 10-year Treasury yields from 1962-2020 measured on a quarterly basis.

The price-to-earnings ratio is the ratio of the price of a stock (or index) versus earnings per share of the trailing 12-month period.

Stocks, based upon 2020 earnings estimates, appear to be expensive. However, based upon 2021 earnings estimates, they’re not. So, what are the odds of achieving those earnings estimates? Consider this: S&P 500 profit margins declined materially in 2020. If those margins were to return to 2019 levels—with no material increase in top-line sales—those 2021 earnings estimates would be achieved.

There is of course downside risk. Tragically, the virus is likely to rage in the first quarter of 2021, curtailing some economic activity. There is upside as well—high household savings and pent-up demand for activities curtailed by the pandemic could drive a particularly robust recovery toward the second half of the year. Those 2021 estimates do seem reasonable, and by extension, so do valuations.

Is It Finally Time for the Value Rotation?

While the S&P 500 may be reasonably valued, this may not be the case for all market segments. In particular, the S&P 500 Growth Index nearly doubled the return of the S&P 500 in 2020. Even for investors who are not concerned with growth valuations (more on this in the next section…) a rebalancing may be called for. The standard approach following a run of growth stocks such as this is to rebalance toward value stocks.

Dividend Growth—Quality at a Reasonable Price

Source: Bloomberg, as of 12/31/20. Data shown represents ratios.

Price-to-book value is the ratio of the price of a stock (or index) versus book value per share.

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. It provides insight into how efficient management is at using its assets to generate earnings.

Value stocks are certainly cheap, but they aren’t necessarily poised to rebound, meaning they may represent a “value trap,” and stay undervalued for a long time. With that in mind, this time around the more prudent choice may be to rebalance to—and perhaps even tilt toward—quality stocks (defined as stocks that have delivered higher return on assets, an important marker of quality) that have been left behind by large-cap growth.

A prime example: The S&P 500® Dividend Aristocrats®—companies that have increased their dividends for at least 25 consecutive years—usually trade at a premium to the broad market. Currently, they’re trading at a substantial discount, and while not quite as cheap as value, they’re delivering nearly triple the return on assets—an important marker on yield—and even a slightly higher dividend yield. (Read more on this in our equity section).

The higher quality of these dividend growers may come in handy, particularly as the world is not quite out of the woods yet with regard to the pandemic. These dividend growers present a compelling alternative to value stocks, which may still represent a value trap.

What About Growth Stocks?

The year 2020 was a lot different from 2000. Many growth stocks and technology-oriented growth stocks were supported by real fundamentals—not just hype. However, the challenge in investing in growth stocks is to find opportunities where growth can meet or (ideally) exceed expectations.

We are in a pandemic that saw many economic and societal trends put on extreme fast-forward. Trends like the future of work, genomics and telehealth, and the food revolution point to areas of the economy that are likely to experience outsize growth. Focusing on companies that participate and profit from these trends—which can be achieved through thematic investing—can help put the wind at one’s investing back and can be an effective complement to quality stocks such as dividend growth.

For an added bonus, there are even thematic investment opportunities where valuation is favorable. For example, 2020 saw extremely strong performance from the ProShares Online Retail Index, and the incessant march toward online retail is unlikely to pause post-pandemic. The surprise: The constituents of that index are trading at a 30% price-to-book discount to its neighborhood—the consumer discretionary sector, and a 20% discount to its adjacent neighborhood—the technology sector.

Can the Small Cap Rally Persist?

It may make sense to include allocations of mid- and small-cap stocks to a 2021 portfolio of quality (again, defined as stocks that have delivered higher return on assets). The recent rally in small-cap stocks has only put a tiny dent in a valuation discount that has been over a decade in the making—and it’s true for midcaps as well.

Source: Bloomberg

Price-to-book value is the ratio of the price of a stock (or index) versus book value per share.

The choice of quality over value in mid- and small-cap stocks is perhaps even more compelling than in large-caps stocks.

Small- and Mid-Cap Dividend Growth—More Quality at a Reasonable Price

Source: Bloomberg, as of 12/31/20. Data shown represents ratios.

Price-to-book value is the ratio of the price of a stock (or index) versus book value per share.

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. It provides insight into how efficient management is at using its assets to generate earnings.

As one moves down in size in the equity market, quality—as defined by return on assets—deteriorates. Return on assets for mid-cap stocks is anemic, and even negative in aggregate for small-cap stocks. As in large caps, mid- and small-cap dividend growth stocks such as the S&P MidCap 400® Dividend Aristocrats® and the Russell 2000 Dividend Growth indexes are trading at unusual discounts—but delivering substantially higher return on assets and even higher dividend yields.


A green month ending a predominantly green year—despite a pandemic.

Source: Bloomberg

Equity Perspectives
Dividend Stocks in 2020—A Critical Distinction

At the outset of the pandemic, attention for many equity income investors turned immediately to concerns over the sustainability in dividends. The impact of the pandemic seemed sure to force many companies to cut or suspend their dividends, and investors feared the cuts would rival the S&P 500’s 21% decline in dividends from the financial crisis in 2009. Thankfully, the worst of the concerns didn’t quite materialize. While there were a significant number of negative dividend actions, more companies raised their payouts in 2020 than cut them. In fact, the market’s total dividends are expected to be essentially flat in 2020 as compared to 2019 levels.

But that’s not the whole story, and 2020 reminded investors why dividend sustainability is so important. While total dividend payouts held up better than expectations, it was critical to distinguish between dividend growers and dividend cutters as the performance differential between the two was large. Companies that cut their dividends in 2020 declined on average by 6.5% and fared much worse than the group of companies in the S&P 500 that raised their dividends, which on average returned 12.7%. High dividend yield strategies, such as the Dow Jones U.S. Select Dividend Index, which included many of the dividend cutters, significantly underperformed a dividend growth strategy like the S&P 500 Dividend Aristocrats Index.

2021—A Return to Dividend Growth?

Now that the worst of the effects of the pandemic are likely behind us, the focus for equity investors inevitably changes for 2021. With the powerful rally from the March lows combined with an expected deterioration in 2020 S&P 500 earnings of approximately 14%, investors are left to wrestle with extended valuations on a trailing price-to-earnings basis. As mentioned in the summary, yes, historically low interest rates provide at least some rationalization for the market’s price levels. However, at some point, earnings will need to rebound to support valuations, and the challenge will be to identify companies best suited to deliver on those expectations. For now, earnings for 2021 are expected to increase approximately 22% from 2020 levels. We note in our summary that the S&P 500 Dividend Aristocrats have delivered higher return on assets, an important marker of quality. These companies may be best positioned to deliver on the expected earnings rebound as they have historically delivered more consistent and more resilient earnings streams.

Even in a challenged year for dividends like 2020, the Dividend Aristocrats managed to grow their dividends at an impressive rate of 14%, well in excess of the overall market, which was essentially flat. Growing a dividend is perhaps the most obvious signal that management can send in their confidence of a company’s ability to deliver consistent and growing cash flows and earnings, which ultimately are the lifeblood of dividends.

Source: Standard & Poor’s

The Technology Conundrum

As we stated in the introduction, one of the key questions for 2021 is where to find growth, and even more challenging, where to find it at a reasonable price. Perhaps the most obvious place that will likely remain front and center for 2021 is technology. In general, technology stocks today are more mature, are better capitalized and produce more attractive margins than they did historically. Many names today are even paying and growing a dividend—a marked change from even 10 years ago.

However, the relentless run up in prices over the last decade has left tech stocks at approximately 28% of the S&P 500’s total capitalization—and just a handful of tech stocks represent a significant portion of the entire sector. For good or bad, the performance of just a handful of the largest names will have an outsized impact on the sector and even the overall market with a traditional market-cap-weighted approach. One simple alternative is an equal-weighted approach, a technique which, similar to the overall market, makes valuations look more reasonable.

Perhaps a better idea is to adopt a dividend growth approach to the sector through an index like the equally weighted S&P® Technology Dividend Aristocrats®. Not only does this strategy offer better valuations, but also access to an increasingly critical sector for dividends. Tech companies in the S&P 500 had more than doubled their second-quarter 2020 dividends compared with what they paid five years earlier. That was the highest growth rate of any sector and far exceeded the increase for the S&P 500. (Source: S&P Dow Jones Indices)

Source: FactSet, as of 12/31/20

Fixed Income Perspectives
A Quick Review of the Bond Market

Fixed income markets exceeded many investors’ expectations in 2020, with the U.S. Aggregate Bond Index returning 7.51%, its second-highest annual return over the past 10 years. The primary source of the bond market’s return in 2020 can be attributed to falling interest rates. Rates fell anywhere between 74 basis points (bps) and 150 bps across the Treasury curve during the year. While investment grade credit spreads had a bit of a wild ride prior to the Fed’s intervention in March, it may come as a surprise that, after all was said and done, they widened by just 2 bps in 2020.

Source: Bloomberg

Can Rates Go Any Lower?

While longer-term Treasury yields have been on an upward trend since August of 2020, the 10-year yield remains 100 bps below where it stood at the end of 2019. With rates having fallen dramatically during the year, it begs the question—can they go any lower?

Low interest rates help to stimulate many areas of the economy by keeping borrowing costs low. This can benefit consumers and corporations while also having implications for government spending. At current levels, the government can fund debt at a level so cheap that some believe we can just “print” money to support stimulus measures. And in a time where so many are struggling amidst the pandemic, fiscal stimulus may be more important than ever.

It’s important to consider, however, the amount of debt the government is taking on. Rather than looking solely at national debt levels, it is more useful to look at debt relative to gross domestic product (GDP), similar to how it is more insightful to look at an individual’s debt to income ratio rather than just their debt level. For example, an individual with $50,000 in debt and an income of $30,000 is in a substantially different financial situation than an individual with $50,000 in debt and an income of $400,000. Who would you feel more comfortable lending money to?

U.S. Debt Versus Gross Domestic Product Over Time

Source: St. Louis Fed, 1/1/2000-7/1/2020

The U.S. debt-to-GDP ratio reached a peak in the second quarter as the government funded stimulus measures to support the economy. How much debt is too much, and how can we access the risks?

Fitch Ratings has kept U.S. Sovereign debt at the highest credit rating available, AAA, where it sits alongside eight other developed countries. However, the rating agency revised its U.S. outlook to negative on July 31, citing concerns with debt and deficit levels as well as the potential for political gridlock. The reduced outlook has implications for Treasury bond yields, which can increase in order to compensate for additional risk. In fact, the 10-year Treasury yield has risen 50 bps off of the lows seen in the beginning of August.

How to Combat a Steepening Yield Curve

The Fed has indicated that it expects to keep the Fed Funds rate close to zero for the next few years. With longer-term rates already on the rise, the outlook for Treasury bonds is a bit bleak. Corporate bonds may be the better option, with high yield bonds looking particularly attractive if the pandemic subsides and we see economic expansion continue following impressive GDP growth numbers for the third quarter. While investment grade credit spreads are on par with where they were at the start of 2020, high yield spreads remain 24 bps wider. Taking on credit risk within a fixed income portfolio may be more prudent at this juncture than taking on interest rate risk. In addition, high yield bonds typically involve less interest rate risk than investment grade bonds, with the high yield bond market having a duration of 3.58 versus 8.84 for the investment grade bond market as of December 31. It is important to note that while the high yield bond market has reduced interest rate risk, there are additional risks to consider when investing in lower-rated securities. These include a higher rate of default on coupon payments and an increased risk of loss of principal.

Duration is a measure of bond price sensitivity to a change in interest rates.

Other solutions to reduce interest rate risk include hedged strategies such as the FTSE Corporate Investment Grade (Treasury Rate-Hedged Index). Since longer-term rates have begun to rise, the index has outperformed the unhedged investment grade bond market, as illustrated below. During the same time period, the Treasury bond market has fallen 1.76%.

Source: Bloomberg

ProShares Investment Strategy Team

Source for data and statistics: Bloomberg, FactSet, ProShares

The different market segments represented in the performance recap charts use the following indexes: US Large Cap: S&P 500 TR; US Large Cap Growth: S&P 500 Growth TR; U.S. Large Cap Value: S&P 500 Value TR; U.S. Mid Cap: S&P Mid Cap TR; U.S. Small Cap: Russell 2000 TR; International Developed Stocks: MSCI Daily TR NET EAFE; Emerging Markets Stocks: MSCI Daily TR Net Emerging Markets; Global Infrastructure: Dow Jones Brookfield Global Infrastructure Composite; Commodities: Bloomberg Commodity TR; U.S. Bonds: Bloomberg Barclays U.S. Aggregate; U.S. High Yield: Bloomberg Barclays Corporate High Yield; International Developed Bonds: Bloomberg Barclays Global Agg ex-USD; Emerging Market Bonds: DBIQ Emerging Markets USD Liquid Balanced. The fixed income section uses the following indexes: The Aggregate U.S. Bond market is tracked by the Bloomberg Barclays US Agg Bond Index; high yield bonds are tracked by the Bloomberg Barclays US Corp High Yield Index; the broader investment-grade bond market tracked by the Bloomberg Barclays US Corporate Bond Index; the investment grade treasury rate-hedged bond market is tracked by the FTSE Corporate Investment-Grade (Treasury Rate-Hedged) Index and the FTSE High Yield (Treasury Rate-Hedged) Index; the short-term corporate bond market is tracked by the Bloomberg Barclays US Corporate 1-5 Year Index.

This is not intended to be investment advice. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Any forward-looking statements herein are based on expectations of ProShare Advisors LLC at this time. ProShare Advisors LLC undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Investing is currently subject to additional risks and uncertainties related to COVID-19, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and world economic and political developments.

Investing involves risk, including the possible loss of principal.

Bonds will decrease in value as interest rates rise. High yield bonds may involve greater levels of credit, prepayment, liquidity and valuation risk than higher-rated instruments. High yield bonds are more volatile than investment grade securities, and they involve a greater risk of loss (including loss of principal) from missed payments, defaults or downgrades because of their speculative nature. Investments in non-U.S. securities may involve risks different from U.S. securities, including risks from geographic concentration, differences in valuation and valuation times, unfavorable fluctuations in currency, differences in generally accepted accounting principles, and from economic or political instability. Investments in emerging markets generally are less liquid, more volatile and riskier than investments in more developed markets and are considered to be speculative. Investments in smaller companies typically exhibit higher volatility. Small- and mid-cap companies may have limited product lines or resources, may be dependent upon a particular market niche and may have greater fluctuations in price than the stocks of larger companies. Small- and mid-cap companies may lack the financial and personnel resources to handle economic or industry-wide setbacks and, as a result, such setbacks could have a greater effect on small- and mid-cap security prices.

The “S&P 500®, The “S&P 500® Dividend Aristocrats® Index,” and the “S&P MidCap 400® Dividend Aristocrats Index" are products of S&P Dow Jones Indices LLC and and its affiliates and has been licensed for use by ProShares. "S&P®" is a registered trademark of Standard & Poor's Financial Services LLC ("S&P") and "Dow Jones®" is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones") and have been licensed for use by S&P Dow Jones Indices LLC and its affiliates. “Russell 2000® Dividend Growth Index,” and “Russell®” are trademarks of Russell Investment Group. ProShares have not been passed on by these entities and their affiliates as to their legality or suitability. ProShares based on these indexes are not sponsored, endorsed, sold or promoted by these entities or their respective affiliates, and they make no representation regarding the advisability of investing in ProShares.


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