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