What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up about 2.8% in February
- The developed market of Japan was up about 3%.
- Europe and the U.K. were up about 2.6% and 2% respectively.
- Emerging Markets were up less than 1% and Asia (Ex-Japan) were up about 1%
- Global fixed income returns were mostly negative led by high yield bonds.
Where Do We Stand?
- The market continued to move higher after a brief pause in January.
- Valuations remain stretched however the probability of a recession is very low.
- Long term inflationary effects have come into play and bear watching.
- I remain in a position to take advantage of opportunities as we anticipate further economic growth due to pent up demand.
- I continue to rebalance your accounts accordingly.
Markets continued to drive higher in February on the rollout of vaccines and a drop in the infection rate. The second half of the year in much of the developed world is now looking like a “return to normal” albeit one where dislocations could still occur. Virus mutations have been popping up around the world, originating in places like Brazil and South Africa. These mutations could still potentially slow down the return to normal. However, spirits are high on the expectation that we will overcome these mutations much faster than we were able to overcome the original variant.
In the interim economic data continues to show momentum. Fiscal support has boosted demand for goods and the expected Biden recovery program will continue this trend. The trend does come with a cost though as inflation expectations have risen. This in turn has driven bond yields higher as the markets begin to price in these inflation expectations.
Market Pop Quiz
A nice test for the markets will be to see whether or not they can sustain in the face of higher yields. If markets falter significantly it will show us that that the recent rally in asset prices was more speculation-driven than fundamentally driven. However, if the markets can take a punch and keep on climbing (or at least not retreat) we may have the makings of a real recovery bull market. Note though, this next bull market may look very different than the last. A bull market with rising bond yields and rates tends to favor different asset classes and sectors then one that occurs with declining rates. Now would be a good time to review my educational piece on Market Cycles. Click here to review.
Absorb the Unemployed
While the next bull market is always on the horizon, one would be remiss to avoid the issues that we face. In addition to the potential for inflation and higher rates going forward there is a lot we don’t yet know about the economy. The year we have been through has been devastating. Many businesses have closed permanently. Thus, we don’t know how well our economy will be able to absorb the unemployed once they are ready to go back to work. The full recovery may take longer because new businesses (restaurants, etc…) are not opened overnight. The infrastructure is there for a full recovery. The question is is the spirit and capital there?
Overstimulation?
The real long term risk here is that we do too much. Injecting money into an economy that is faltering is great for earnings and stocks in the near term. However it also has longer term risks. Extra money in the consumer’s pocket will always boost demand but it will also boost inflation. Timing is very important here. The most recent $1.9 Trillion package currently winding its way through Congress is not a bad thing, per se. However, it also coming at a time that may be very close to us achieving herd immunity.
When herd immunity is achieved I expect that the pent up demand we’ve talked about over the past few months to occur. And remember, much of the spending that is included in this bill will be realized in 2022 (state and local governments, education, etc…). So the result may be we see a big boost in local government spending at the same time private citizens are back out on the street spending their pent up dollars. A double injection of growth that can only drive outsized jumps in inflation. Outsized jumps in inflation leads to bond market freak-outs. Markets like things to go up but don’t like “maybe you had too much too fast” as the Grateful Dead so eloquently put it. This is a real risk for late 2021 and 2022.
Spanish Flu Redux?
Recently a client brought up the analog to today and the 1919 pandemic. During the 1919 pandemic the stock market barely faltered. Once the flu subsided the market saw an approximately 50% increase during 1919 before faltering over the next two years. The stock market was down about 50% over those two years. The historical context is very important here. The Spanish Flu hit the world at the same time World War 1 was raging in Europe. Furthermore, global supply chains and the interconnectivity of global trade was nowhere near where we are today. I assume much of the action in the markets then was driven as much by news of the war coming to an end as the pandemic.
Post-War Recession
The Spanish Flu during 1918 – 1919 killed an estimated 50 million people. What happened in 1920-1921 had much less to due with the after-effects of the pandemic than with the end of the war. The recession of 1920-21 was mostly due to our inability to absorb returning veterans. Struggles with the transition from a wartime economy to a peacetime economy and mistakes in fiscal and monetary policy also contributed. Lastly, the fact that the Spanish Flu killed an estimated 675,000 Americans, much of them working age adults, likely had some effect on the recession. It just wasn’t the primary factor leading to this short but dramatic recession.
Concluding
Governments around the world find themselves in varying stages of the exit from this pandemic. Some, like the UK, have done remarkably well in administering the vaccines. Others have not fared as well. Whether it is due to availability of the vaccines (Developing Markets), cultural reasons or simple infrastructure issues is dependent on the country. We do know this, in the coming months things will open up to the point where normalcy returns. On the path to that point we remain close to target allocations with some “dry powder” to take advantage of buying opportunities as they present themselves.
If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.
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