Expansion

A lot can change in a year. Looking back at the stock market on April 1, 2020, the S&P 500 began the month by falling 4.4% to 2470. This was in the immediate shadow of March 2020, one of the most volatile months in my lifetime, anchored by March 16 when stock prices fell 12% in one day. Today, the S&P 500 is over 4000 (62% higher than the March ’20 low) and shows no outward signs of slowing down. Last month saw a buoyant trend continue, as stock prices rose 4.2% (as measured by the S&P 500) and are now up a sturdy 6.2% year to date.

Many investors are being caught wrong-footed by the regular shifts in the types of stocks the market is rewarding. When the potential for robust economic expansion began to take shape late last year, investors bought value stocks, which benefit most as the economic tide comes in. They also began to buy small cap over large cap, and low quality over high quality. My concern with many of these shifts is whether or not the trades have legs – and my suspicion is they do not.

The backdrop is challenging. Prominent concerns for the future months include higher interest rates, higher taxes, higher inflation, commodity costs and of course, new and emerging strains of the virus. None of these have derailed stock prices as many investors pre-emptively anticipated, which has led to numerous directional shifts in the market.

In my opinion, we need to pay attention to a number of emerging trends and events which could be early warning signs of more significant change brewing. The meme trading of stocks like Game Stop, reflects reckless group risk taking, as the stock trades at over $170 a share and has not earned a dime since 2017, according to FactSet estimates. The implosion of the family office Archegos Capital and the complicit behavior of multiple global banks writing swaps blind to the illiquidity and the systemic threat, harks back to the near melt down of the system in 1998 when Long-Term Capital Management suddenly failed. When they do, things tend to go wrong quickly.

We have also seen unexpected stresses on the supply chain. When the container ship the Ever Given became stuck and blocked the Suez Canal, it was reported that as much as 10% of the world’s trade was on hold. Another current crisis is the chip shortage. This is not something we think of often, but largely attributed to crypto currency mining, we now face a shortage of chips for the production of new cars and other consumer products.

Yet, there is a lot to support the current bout of optimism on Wall Street. Interest rates remain near historic lows. The pending fiscal spending from the American Jobs Plan is long overdue, and will begin to make up for decades of underspending on critical infrastructure that benefits everyone. The development of vaccines has been nothing short of remarkable, as is their effectiveness, and with the new administration their dissemination has increased to the current 4 million doses a day. Immunity is broadening and expectations are that greater than 80% of the US population will have been vaccinated by early summer.

My sense is the coming wave of economic growth will be eye-opening and with it, we should expect an extended period of outsized earnings growth. Current bottom-up EPS estimates by FactSet indicate over $175 a share in earnings for CY ’21 and over $202 for CY ’22. Both of these figures are record highs and imply growth rates of over 25% and 14% respectively. These figures are enormous in relation to S&P 500 historical earnings numbers and the market today is placing a 20x PE ratio on these high expectations.

The last year has been a true challenge, something few of us have ever experienced in such scale. People have saved a lot of money, not doing many of the things they had in their pre-covid lives. The new normal will be a blend of the adopted digital lifestyle with a more live-now vibe that germinated during the lockdowns. The financial markets are anticipating this and, as a discounting mechanism, are already reflecting how things are expected to be 12 months from now.

I hope you have your vaccine or, if not, will in the near future. In the meantime, please be safe out there, and don’t hesitate to check in if we have not been in touch.

Bruce Hotaling, CFA
Managing Partner