After a robust 2020, stocks measured by the S&P 500) began the New Year on a mixed note, returning -1.01% for January. However, there is no need to read a lot into this. Stock prices, for the most part, are still attached to the conditions that prevailed in December of last year. Not much has changed: the stock market is expecting another stimulus package to be passed, and the Federal Reserve continues to signal it has no intentions of raising interest rates anytime soon. Stock prices are remarkably interest rate sensitive, and with rates at rock bottom, any upward move will pressure the market’s P/E ratio and bring prices down. This is not on the horizon yet but talk of higher inflation and higher levels of GDP will spur concern.
As we lap the first anniversary of the date the WHO declared the COVID-19 outbreak a global health emergency, news on the virus is finally, marginally improving. Johnson & Johnson is applying to the FDA for emergency use authorization for its single shot vaccine. AstraZeneca and Novax also have vaccines on the cusp of approval by the FDA. 23M Americans have received the vaccine, and over 26M Americans have confirmed cases, according to the WHO Coronavirus Disease Dashboard. With the total population of the US @ 330M, it remains unclear what needs to have had the vaccine or the virus in order to establish herd immunity. It is possible the virus becomes endemic and vaccinations and re-vaccination to sustain immunity become the norm.
The popular news this past week echoed the roaring ‘20s. Techniques akin to the “pump and dump” schemes popularized by Jesse Livermore over 100 years ago took hold of trading in GameStop shares. In today’s world of social media, “meme trading” has become a thing on Robinhood Markets Inc. free, app-based trading platform and the surge in trading caused Robinhood to raise $2.4B as collateral for clearing requirements. The episode is largely a distraction and shows the capital sensitivity of small broker-dealers. It’s not clear whether or what type of regulation the SEC may need to bring as the use of message boards, AI and social media scraping appear to have been used to knowingly manipulate the price of a stock, which is a violation of securities laws.
There is a vast difference between trading and investing – clearly to make an investment, you must trade (buy or sell) a stock, but short term, spontaneous and uninformed bets on short term price movement have nothing in common with investing. The issue is not likely to threaten the underpinnings of the broader market, which is organized to allow for the creation of and access to capital. There is considerable evidence that only a tiny percentage of people involved in day trading make money and this type of activity in today’s social media world begs for some updated regulations. Sadly, one trait of stock market behavior is that those who can least afford a loss (those with fewest resources) are the most likely to take outsized risks.
For us, the basics of fundamental investing remain in place. Quality, transparency and liquidity are primary criteria in all our investment models. When prices move without any fundamental reason/underpinning there may well be a profit opportunity, but it is not tied in any way to earnings or other measurable fundamentals. The earnings outlook for the S&P 500 remains strong, and the market is beginning to look forward into 2022. According to FactSet, S&P 500 companies are reporting 4Q ‘20 earnings well above expectations, and are producing the highest level of positive surprises for any quarter since 2008. We view our opportunity set as a market of stocks with attractive themes, such as clean energy, emerging technology, EV technology and stocks still in the recovery phase from the pandemic induced recession.
It’s that time of year, and taxes are upon us. Unlike last year, we are back on a regular tax filing cycle. You will receive your 1099s in the mail, and you can also access them from the Schwab web site. Please let us know if we can help, and as always, we look forward to hearing from you. Please do not hesitate to call us if we have not been in touch recently.
Be safe out there.
Bruce Hotaling, CFA
At long last we turn the page on one of the most tumultuous years in my lifetime. The House of Representatives voted to impeach the president for abuse of power in January. By March, cases of the coronavirus had been found in all 50 states. The stock market responded with one of the most dramatic drops in the last 40 years (-34% in 1987, -34% in 2002, -49% in 2008, and -34% in 2020). In June, millions protested in support of Black Lives Matter. The election in November felt as though it spanned three strained months. Now, an unprecedented movement is underway to overturn the popular and electoral college votes. Finally, beyond all common sense, the year closed with stock prices, measured by the S&P 500, up 3.8% for the month of December and up an eye opening 18.4% for the year. Amidst utter chaos, the stock market is evidently focused elsewhere.
We will probably never know the true disconnect between what was happening on Wall Street and what was happening on Main Street. This will likely become the work of analysts and scholars for some time. As the dust settles, and we turn toward what may unfold in 2021, there are a multitude of causes and outcomes for us to consider. Some we can clearly see, and others will surprise us.
On the positive side, there is a lot to support owning stocks. Vaccines by Pfizer-BioNTech, Moderna and AstraZeneca/Oxford are being administered and still others are in the pipeline. The stimulus already approved by Congress, with likely more to follow, will prove a stabilizer for the economy, likely all the way into 2022. Analyst earnings estimates project record earnings for the S&P 500, in the range of $170 per share. The Fed Funds rate is currently 0.25% and I would not expect interest rates to rise in a threatening way. The Fed’s Chair Jerome Powell, alongside Janet Yellen as Secretary of the Treasury, ought to give the markets comfort. Demand for stocks will be supported by the low rates which limit quality investment alternatives.
On the other hand, there is a lot that could be disruptive in owning stocks. As was the case in the response to the Financial Crisis, politicians now may use debt limits as a mechanism to foil attempts to rebuild the economy. The Federal budget deficit is expected to top 15% of GDP in 2020, and the total deficit now exceeds 100% of GDP, the highest level since WWII. Labor force growth is turning negative, and output per worker is declining, both ominous signs for future GDP growth. At some point, tax revenues will need to be found in order to begin to rein in the deficits, especially in light of low economic growth. If in fact interest rates do rise, they will suppress the market’s PE ratio, make the cost of doing business (owning homes, consumer credit) more expensive, and make financing the federal deficit more costly.
My expectations are that the markets will enjoy a more transparent and clearly policy based attitude from Washington with respect to foreign trade, environmental policy, public health and general support for the whole of the economy. I think some of the disparities in the economy that have been exacerbated by the pandemic will begin to be addressed. While I do think returns have been pulled forward to a certain extent, there are a range of opportunities in play such as electric vehicle technology, alternative and clean energy, ESG themed investment approaches, and continued work-from-home technologies. We are busy looking to incorporate these emerging themes into our portfolios.
Our basic work will not change in 2021. We will continue to put our energy into both leading-edge and time-tested investment management technique with the intent of making money owning quality equities. We will also focus on linking our investment management capabilities with your financial planning needs, to make sure your exposure to risk, asset allocation and future planning is appropriate.
While in many ways nothing has changed from a week ago when it was still 2020, in other ways everything has changed. No doubt 2021 will bring its share of unexpected events. It is our work to navigate and profit from them that will make the difference this time next year.
Happy New Year!
Bruce Hotaling, CFA
Stock prices, measured by the S&P 500 jumped a remarkable 10.7% in November, and are now up 14% year to date. November’s returns are the third best for any month over the last 20 years, led by 12.7% in April ’20 and 10.8% in November ’11. To contextualize these remarkable figures, it is worth pointing out the worst monthly returns during the same 240-month span. October ’08 saw stock prices fall 16.9% with the onset of the great financial crisis. In March ’20, COVID 19 hit, driving prices down 12.5%. Finally, in September ’02 prices fell 11% resulting from the dot com bust, 9/11 and a horrific recession (from its peak in March of ’00, the market had fallen 50% by October ’02). The market will move to the extreme, both up and down, and we often don’t know why until after the fact.
November’s jump in stock prices is likely due to multiple factors. The first, and most important, was the election of Joe Biden and Kamala Harris on November 3rd. The market responded favorably with the expectation that we will see 1) sensible, forward-looking policies to stimulate and rebalance the economy; 2) renewed emphasis on alternative energy and environmental sustainability; and 3) definitive steps taken to begin addressing some of the economic and social barriers perpetuating embarrassing levels of inequality. Importantly, the nonsensical trade war will end, and this alone will provide a boost to GDP.
Positive data was released by Pfizer/BioNTech on 11/9, Moderna on 11/16 and Astra Zeneca/Oxford on 11/23, providing a monthlong hope trade premised on economic re-opening. However, the virus is raging with new daily cases in excess of 220,000 and deaths in excess of 2,000 per day. When the vaccines are approved, the difficult task of prioritizing who receives the vaccine first will come into play. The roll out means help is on the way, but it’s not at all clear when enough of the population will be adequately protected. Nonetheless, November saw investors buying stocks with the expectation the virus will be contained.
Another fundamental driver of the recent stock price surge is corporate earnings. Q3 results were better than feared, we are seeing more companies reinstate guidance and forward expectations are high. In 2Q, earnings fell by over 20% due to the implosion of business activity in the travel/leisure sectors on fears of the virus, in the energy sector with oil prices less than $1 per barrel and in the financial sector with banks making huge provisions for the anticipated loan losses. Now, as businesses attempt to emerge from the pandemic-driven recession, stock prices are discounting a substantial recovery in earnings by late ’21.
November market activity generated a dramatic rotation from growth stocks to value stocks, along with the re-emergence of smaller cap stocks. This pro-cyclical trade is premised on a full economic recovery, rising interest rates and inflation. In my opinion, the cyclical trade has largely run its course and the economy is going to take a long time to fully recover. Stimulus aside, interest rates will remain low for a long time and there are structural shifts in effect which make a return to traditional levels of growth and inflation unlikely.
In my opinion, a drawn-out recovery does not mean that stocks cannot continue to perform. First of all, the economy is not the stock market. Second, we own select stocks in which we are confident they can generate above market returns. Growth, free cash flow and dividends remain critical fundamental qualities we screen for in our selection process. We have shifted our focus to accommodate the cyclical trade, and own numerous stocks today we would have never considered owning prior to the pandemic. We will watch and make further adjustments as circumstances dictate.
As we approach year end, we are available to review your accounts with you, with a special view towards capital gains. The good news is that returns have been solid this year and we can reserve funds for future tax payments. Tax planning, or at least tax awareness, is prudent at this time of year. Please feel free to check in with us; we are continuing to primarily work from home with limited work from the office. Take good care and please be safe out there.
Bruce Hotaling, CFA
October was a frightening month in the stock market, and not just due to Halloween. Stocks, measured by the S&P 500 fell 2.66% for the month, and are now up a slim 2.77% as of month end. Stocks were uncharacteristically buoyant to close out the summer, leaving investors scratching their heads. Then successive down months in September and October seemingly foreboded calamitous times ahead.
The election is now behind us. The world seems to have breathed a collective sigh of relief with the announcement that Pennsylvania turned out in favor of Biden. The recent surge in the stock market since election day reflects the market’s acknowledgement the US in fact needs clear and consistent policies with respect to trade, foreign relations and domestic priorities. The potential for a divided government appeases many Wall Street pundits based on the presumption a republican senate will prevent higher corporate taxes and prevent expansion of health benefits and other regulations.
Critically, the pandemic is worsening and is clearly the largest issue facing governments across the globe. The US now has recorded over 120,000 infections per day. In the wake of Sturgis, the virus is raging, particularly in the Midwest. Hospitalizations and death rates are increasing. Winter is nearing and indoor gathering will become a challenge. Until the pandemic is contained, the service side of the economy in particular will remain hostage to the effects of the virus.
The labor force has been severely impacted by the virus. While hiring has picked up, the unemployment rate remains 6.9% according to the US Bureau of Labor Statistics. Labor force participation among women is in decline and minority unemployment has soared. Services are a large and visually apparent component of the economy, and they remain well off pre-pandemic levels. Longer term the risk is unemployment becomes entrenched and economic growth stagnates. Vast government stimulus, and public/private partnerships will be necessary to boost labor force participation rates and allow for a re-absorption into the workforce.
The Federal Reserve will continue to play a critical role in the economy’s ability to get back on its feet. Interest rates are now likely to remain suppressed for an extended period. It is not yet evident what post-election fiscal stimulus might look like. Clearly state and local governments desperately need help as their tax receipts have been ravaged.
Overall, stock price multiples are historically high, selling at approximately 21.5x expected 2021 operating earnings of $161 a share. For the market to move meaningfully higher from here, gains will have to be driven by stronger earnings. In spite of the country’s economic plight, 2021 may produce near all-time high corporate profits. It is feasible for the S&P 500 to generate $176 a share in earnings by mid-2021. That was the same earnings level we saw in 2019 just before the virus descended on us. This would support what many feel is an emerging bull market in stocks.
At the moment, I see a host of opportunities in the stock market. As I have discussed before, a market of stocks is quite distinct from the stock market. Our key focus is on quality stocks showing continued improvement in earnings. Of equal importance at this moment are dividend stocks. Interest rates are historically low, and further multiple expansion is unlikely. I think this backdrop will lead income investors away from bonds and toward more attractive dividend streams.
My preference is to continue to orient around strong growth stocks, while onboarding select value and cyclical plays. I feel the digitized economy will continue to grow, and dominate the market’s attention. Further, our research is focused on alternative energy, utility, and consumer stocks. We feel that these sectors will extend the strength they’ve exhibited during the latter part of the year.
Please feel free to call us to review your portfolio. I know we have been in touch with many of you with concerns leading up to the election. We cannot discount the potential for disruption in the near term, but the longer term outlook looks better now than any time in the last several years.
Please, be safe out there.
Bruce Hotaling, CFA
Stocks began 2020 on a bit of a sour note before the pandemic. In February and accelerating in March, prices truly fell off a cliff as COVID-19 spread around the world. Then, as though with a flick of a switch, prices reversed on March 23rd and began a remarkable five-month long run. For some reason, September was the month prices finally chose to take a look in the mirror and pause. Measured by the S&P 500, stock prices fell in the month of September 3.8% and are now up 5.6% year-to-date. A lot of investors are surprised that they have a positive return at all considering all that’s gone on this year.
The good news is that the market has recovered from its March lows. But looking more closely, very few stock prices have actually recovered. For example, looking at several different segments of the total market on a year-to-date basis, we see troubling divergences. On one hand, the Nasdaq 100 (QQQ) is up 30%, and the S&P 500 Growth Index (IVW) is up 20%. To a large extent, these heady returns have been driven by the FAANG + M stocks (Facebook, Apple, Amazon, Netflix, Google and Microsoft), and a handful of other high-growth names. In stark contrast, the S&P 500 Value (IVE) is down almost 11%, the DJ Dividend Index (DVY) is down 19%, and the S&P 500 equally weighted is down 4%. The number of stocks not participating is reason to check one’s blanket optimism.
In some respects, the market has been trading (daily ups and downs) with an eye toward the approval and distribution of a safe vaccine against the virus. Moderna, one of the leading pharmaceutical companies working to produce a vaccine recently announced that they are unlikely to have a vaccine ready until March or April 2021. Shares of more economically sensitive stocks (cyclicals) and shares of more value aligned and higher dividend paying stocks tend to respond positively to good news surrounding vaccines. One thing I take away from this is that the market will, in all likelihood, not begin to “normalize” until there is in fact at least one vaccine widely distributed and widely accepted.
Optimistically, we are seeing a general recovery in earnings – primarily driven by the digital, cloud, and software side of the economy – spread across a range of sectors and industries. From a fundamental perspective, this is an important positive for stock prices looking forward. I think there will be continued improvement on this front and we may well see operating earnings numbers for the S&P 500 by late 2021 that are similar to 2019’s numbers. That would represent a relatively quick exit from the current recession in relation to what happened in the dot-com recession in 2001 and the housing bubble recession of 2008.
A more circumspect view is that economic change may have been catalyzed by the pandemic in ways that are not apparent yet. We are in uncharted waters. Radical change in the workplace and challenges with higher education feeding young technocrats into the new economy are works in progress. I think the pandemic has quite remarkably pulled the economy forward by several years. There are millions out of work who will need to be re-educated and re-integrated into an economic structure that may be permanently changed – and this will likely take longer than most would like to admit.
The large and uncomfortable elephant in the room is the upcoming election. At the moment, polls indicate a change in government, and this would clear the way for more fiscal stimulus. The stock market is clearly anticipating this outcome and has priced it in already. I think that the US economy, its leading role in the world, and in turn, the stock market, will be best served through more consistent, well thought-out and more clearly communicated policies from Washington.
As ever, we are watching closely. In past times when we have faced challenging market conditions, we found it prudent to focus on owning high quality assets – stocks for which we have full transparency into their pricing and their financial conditions. We also require ready liquidity, which may sound odd, but when things go wrong, lack of liquidity can be problematic.
In the meantime, please do not hesitate to call if we have not been in touch. We are working both in the office and remotely and look forward to speaking with you. Please, be safe out there.
Bruce Hotaling, CFA