What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were down about 1% in January
- The developed markets of Japan was flat.
- Europe and the U.K. were down about 1%.
- Emerging Markets were up more than 3% and Asia (Ex-Japan) were up about 4%
- Global fixed income returns were mixed led by high yield bonds.
Where Do We Stand?
- The market experienced heightened volatility around technically driven selloffs.
- Valuations remain stretched while the prospect for further volatility remains.
- I remain in a position to take advantage of opportunities but see the case for further economic growth strengthening.
- I continue to rebalance your accounts accordingly.
The month of January started off strong, continuing the advance we have seen in global equities over the past few months. The global rollout of vaccines and the prospect for more fiscal and monetary stimulus had helped overcome the perceived negative effects of current economic restrictions. As sentiment became overly bullish, many market participants were hyper-aware of any negative surprise that could create volatility. At the end of the month we got just that in one of the most unexpected ways.
I Reddit Somewhere
Toward the end of the month, young traders using internet forums implemented a “short-squeeze” in several heavily shorted stocks. Hedge funds were looking to profit from the demise of these stocks. The goal of the forum traders was to inflict pain on the hedge funds while also turning a nice profit. The short squeeze was successful and the stocks of several companies rose unexpectedly and quickly, resulting is massive losses for several funds. This led to the fear that these losses would in turn force these funds to sell other stocks to raise cash. Thus, having a cascade effect on the overall equity market.
Pent Up Volatility
Volatility can happen for any number of reasons and oftentimes occurs for reasons no one was thinking about. But remember, economic fundamentals and activity are what determines stock prices over the long term. The economic fundamentals that have lifted equities over the past year remain in place. The likely strong rebound in growth that will accompany the rollout of vaccines globally remains in place. This is because there is pent up demand for many things within the consumer’s basket of goods and services. Travel and retail purchases that have been delayed for more than a year come to mind.
Capital in the Wings
On the corporate side, management teams have now spent several years grappling with uncertainties at the macro level. Starting in 2018 they faced investment decisions through the prism of a hard landing in China, a trade war and now a pandemic. This led to a reduction in investments in equipment and new technologies. With the emergence of lower cost operators that have embraced automation and technological advancements, one can only expect capacity investments to be forthcoming by these larger players. With liquidity rampant and lending rates extremely low, capital expenditures should begin to flow again. This further supports a strong fundamental recovery.
Capital in the Capitol
The Democratic victory in Georgia handed them control over Congress. This should boost growth in 2021 as the new administration has proposed a $1.9 Trillion “Rescue Plan”. Even if this number were to get trimmed down, the economic impact would still be dramatic. The combination of stimulus for 2021 could approach 10% of GDP. If implemented efficiently, this transfer of wealth to private individuals could further boost growth and in turn corporate earnings. In the event of a successful vaccination campaign, one can see 2021 as a turning point in our economy.
Prevailing Tailwinds
The tailwinds that have fueled the advance in stocks over the past few months include low interest rates (and the Fed’s promise to keep them there), high levels of liquidity, fiscal stimulus and the potential for more, and better than anticipated corporate earnings. Volatility can happen at any time for any number of reasons, never ruling out a correction.
If that correction should come, I believe it will be short-lived for several reasons. One, the fundamentals do not portend a market destined to collapse. Two, the new administration will do everything in its power to avoid a long, protracted economic downturn. Three, pent up demand by consumers and corporations can be a massive driver of economic activity going forward.
The pause in the market rally we saw in January was a natural occurrence. While it may have happened for “unnatural” reasons I see no reason to not remain cautiously optimistic on our economy going forward.
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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