What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up about 5% in April.
- The developed market of Japan was down about 3%.
- Europe and the U.K. were up about 2% and 4% respectively.
- Emerging Markets were up more than 2% and Asia (Ex-Japan) were up more than 2%
- Global fixed income returns were mostly positive led by Emerging Market Debt.
Where Do We Stand?
- The market rallied strongly after a strong start to Q1 economic data releases.
- Valuations remain stretched however the probability of a recession is very low.
- The time horizon for a pullback or correction is nearer than markets think.
- 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.
Equity markets around the world had another solid month in April with the S&P 500 leading the way. US Large Cap stocks are now in double digits for the year after returning almost 20% in 2020. The past six months have seen markets preoccupied with expectations of a rebound in economic activity. This expectation was validated with actual facts in April as economic reports for Q1 and the month of March hit the wires.
Good Data
The pace of job growth accelerated while retail sales grew almost 10% in March alone. The US economy grew at an annualized pace of 6.4% in the first quarter, well above historical averages. With the vaccine fully being rolled out and cases looking to be under control (barring a few “hot spots”), the global consumer has begun to re-engage. And they are flush with cash, having saved well above average the last year as well as having received several stimulus payments along the way.
Excellent Data
This means we are likely entering a period of excellent economic data. The pace of growth looks likely to accelerate even further from here and the Federal Reserve is likely to remain sidelined for some time. The Fed will need to see some substantial progress on employment before they begin to dampen economic growth. The Fed’s goal of “maximum employment” is both a blessing and a curse in this regard. Currently, the US sits at about 6% unemployment after having gone up to almost 15% in the depth of the pandemic. That is still almost double what it was before the pandemic. The recovery has been excellent but the work of getting people to work is not nearly done. Likewise, that last 3% very well may prove to be sticky.
Transitory Inflation
If it does in fact prove to be sticky we would be in a situation where asset values continue to rise, unsustainably. If economic data is booming, corporate earnings are rising and the Fed is not reducing their programs the result is price increases. Too many dollars in the system. This leads to asset price inflation as well as inflationary pressures on goods and services. We are already seeing this in some areas of our economy (Real Estate, Crypto, NFT’s). The Fed has labelled this rise in inflation as “transitory”. With no crystal ball on how long this transitory phase continues or the potential damage it could do to the recovery, a word of caution is wise.
Too Bullish
There is undoubtedly excessive bullish sentiment in the markets right now. Certainly, being bullish as economies around the globe are re-ignited is not a mistake. However, the data shows it may be excessive. Right now about 67% of money managers are “bullish”. That number was 54% in the Fall. Those that are “bearish” number only 7% after being a more reasonable 13% in the Fall. Furthermore, the average portfolio right now is 67% Stocks, 17% Bonds, 7% Cash, 8% Real Estate and 5% Gold. Typically the average portfolio is only 60% Stocks. At the same time, margin debt has grown 60% year over year. This all tells me there is a lot of speculation right now. Maybe too much.
Wait for it
Excessive speculation without market pullbacks or consolidation periods is a bad thing. We have not seen a reasonable pullback in some time. In fact, since the 30% + pullback in March of 2020, we have not seen any pullbacks of 10% or more. There was a somewhat decent consolidation in September and October of last year. Since then, the largest pullback was a 4% pullback in January followed by another 4% pullback in February. Historically, market corrections (pullbacks of 10% or more) usually occur somewhere around every 18 months. If you consider the September pullback to not be a real correction, we are now more than 13 months since the last real correction. That’s getting a little long in the tooth. The longer we wait, the larger the pullback we eventually get may be.
Danger, Mr. Market
The S&P 500 is now more than 14% above it’s longer term average (to 200 day moving average). Valuation is also a problem. The P/E ratio (Price to Earnings) is now at a 21 year high of 23 times (Forward P/E). Certainly, I would expect earnings to “catch up” as economies continue to reopen. Remember, the market is an “anticipatory mechanism”. Right now the price is so high because it is anticipating the earnings to grow significantly. But again, that further speaks to prices calming down for a bit until the earnings picture becomes clearer. Put another way, there is a long term danger to the economy and stock prices of the Fed allowing asset prices to continue to climb.
A word on Taxes
Deficit spending during this pandemic has been massive. During any crises such as the one we are coming out of this is to be expected. It is a good thing. It keeps the economy alive until better days are here. However, every post-crisis period has to see some levels of austerity. The post-crisis fiscal tightening in 2010 – 2016 amounted to 6% of GDP. This caused a structural change in the government’s spending and ended up causing secular stagnation. We will need to do something this time around as well.
Undoubtedly taxes is a part of that. Taxes will go up because we cannot sustain the level of deficit spending currently in place. This is a very political process and will start with an eye towards the mid-term elections. There will be “horse trading” in the house and senate. California and New York hold swing votes so possibly a giveback for higher taxes may be the loosening of SALT tax deductions. Also, Manchin from West Virginia is centrist and could dampen the progressive elements in the Senate calling for all out war on the rich.
Concluding
Overall we are in a good place. Today, 2/3 of Americans have some level of immunity to this virus. We will probably be at 75% by the end of May and 85% by the end of June. The pent up demand for goods and services is palpable and will drive economies, earnings and jobs for some time. With the risks mentioned above I remain cautious but invested in the long term success of our country’s ability to overcome. Portfolios are much more invested than they were during the height of the pandemic. Yet we remain with some liquidity to act should we get the aforementioned correction in the coming months.
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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