1999? We Think Not! Volatility…Yes; Bubble…No.
“The most contrarian thing of all is not to oppose the crowd but to think for yourself”
– Peter Thiel
We think billionaire investor and venture capitalist, Peter Thiel, got it right when he pointed out in the above quote that successful contrarian thinking is not based simply on knowing the crowd’s opinion and then automatically going in the opposite direction. Instead, it is grounded in using the data broadly available and then making independent decisions armed with these metrics and facts, regardless of what the crowd is doing. Sometimes we go with consensus when the facts support the popular view. On many occasions, however, we do go against the grain.
Look at 2016, 2018, and 2020 as great examples. In each of these years, the investors were crabby and pessimistic. Many experts in these periods were calling for a dramatic decline in economic activity and for the beginnings of ugly bear markets. During 2016, negative headlines centered on potential fallout from Brexit and the U.S. presidential election.
In 2018, folks were anxious about potential Federal Reserve policy mistakes and concerns that tariff talks would end in an ugly tariff war and an associated recession. In 2020, fears about extended economic shutdown to invest in our health and an ugly election season was sure to end the bull market, so it read in the papers. In each case, the underlying positive news with regard to policy and economic trend carried the day. Headline fears and assumed worst-case outcomes turned out to be far overblown. We remained positive throughout and are pleased that our contrarian outlook helped prevent investors from selling at the bottom of short corrections, missing out on hard rallies off the lows and ultimately on realizing quite robust equity returns in those years. The point, though, is that being contrarian simply for the sake of being contrarian is not the point. Having the courage and conviction to make investment decisions based on disciplined research no matter what the headlines say…that is the point.
Today is no different. We read headlines about froth and bubbles and see comparisons of this market to the risks in such periods as the market peak of 2000 that led to the ensuing meltdown and bursting of the technology bubble. Some of these comparisons stem from the fact that the market rallied strongly off the March 2020 correction. Recent headlines about surges in small pockets of the stock arena, such as the dramatic moves in GameStop for example, have surely fed this fear of a potential market peak as well.
Once again we find ourselves in a contrarian position. We remain positive about 2021 equity returns and, based on the three levels of analysis we conduct—fundamental, valuation, and technical, don’t see froth and bubbles in the S&P 500. The executive summary is pretty straightforward on these three fronts. Market fundamentals continue to trend positive. Economic metrics and earnings growth continue to recover in a strong “v-shaped” fashion. In terms of valuation, one can argue that the P/E level of the S&P 500 appears elevated, but when viewed in the context of this low interest rate and low inflation environment, valuation is actually attractive. Finally, from a technical price trend standpoint, it doesn’t get much better than this. The number of stocks advancing versus declining is close to all time highs. The number of stocks in long-term uptrends is impressive and leadership remains in the hands of more aggressive sectors and not defensive areas, such as utilities and staples, that generally outperform at market tops.
This constructive mix of metrics bodes well for returns over the next 12 months. We’ll examine each of these points more closely.
Now Versus 1999/2000
For those worried about 2000 2.0 and the headlines suggesting there are bubbles all around us, we hope the following metrics are calming:
- In 2000, the 10-year Treasury yield was approaching 6% and the Fed Funds rate was close to that level. Today, the 10-year yield is close to 1.5% and the Fed Funds rate is essentially 0%.1 Stocks don’t suffer much competition from bonds for investor interest like they did in 2000. You might think twice about buying stocks today, too, if you could get 6% on a high-quality bond like you could in 2000.
- The number of stocks advancing versus declining in 2000 was rolling over compared to all-time highs today.
- Earnings and real gross domestic product (GDP) growth were decelerating in 2000.2 In 2021, S&P 500 earnings growth is expected to accelerate to 25%, and in the most recent quarter, close to 80% of companies beat earnings estimates by wide margins and presented strong outlooks for next quarter and the remainder of the year.3 Real GDP growth may exceed 6% in 2021. We have not seen economic growth like this in years.4
- In 2000, personal income and savings rates were falling. Today, personal income is rising at a robust double-digit pace and the personal savings rate is at historic highs.
It’s fairly difficult to see bubbles and peaks when you have the constructive growth metrics outlined above. Certainly, it does not look like 2000.
Fundamentals are Solid, But How About Valuation?
In addition to the solid fundamental economic and earnings data outlined above, more recent news has continued to trend positive. The 5% retail sales growth figure reported for January was stronger than we have seen in several months, unemployment claims fell nicely, industrial production was robust and consumer confidence improved. So, fundamentals continue to strengthen. Despite this, investors understandably do not like the fact that the P/E ratio for the S&P 500 stands at roughly 22 times earnings which is elevated.5 That said, we find valuation attractive in this current, low interest rate environment. The graph below brings this to life.
The chart above captures the difference between the earnings yield of the S&P 500 versus the bond yield that fixed investors enjoy. Normally this spread on what stocks earn versus what bonds earn is a mere positive 60 basis points. Today, it is a far more attractive 250 basis points, making stocks look quite attractively valued versus bonds. For context, back in 2000, this spread was a negative 250 basis points, meaning bonds looked attractively valued over stocks. It’s the opposite situation today.
Clearly, a risk in the market is that rates rise to uncomfortable levels and erase this earnings yield advantage over bonds. We think there is a low probability that this would happen. At present, we think rates and inflation will rise, but in measured fashion. In our base case, which calls for S&P 500 returns of 6-13% in 2021, we assume the 10-year yield may rise to as high as 2.5% versus the 1.5% today. Such a rise may cause volatility as investors naturally fear the worst and that inflation will sky-rocket as soon as we see just a little of it. Human nature is funny in this way. But we think a long-awaited pick-up in inflation is a good thing. We also think it will remain contained and reasonable in the near term.
Our Take on Inflationary Pressures and Market Impact
Three months ago we noted rising inflation as a wildcard risk on the list of wall of worry items. Interestingly, this has become a front and center concern as the fiscal stimulus has continued to stoke the growth in the U.S. economy and the yield curve has continued to rise. While we do expect inflation and rates to rise a bit further, our belief that it will remain tame and at reasonable levels emanates from the following elements:
- The Amazon effect of convenient comparison shopping, global competition and continued innovation in the U.S. puts a lid on potential inflation
- While we are likely to get a one-time bounce in pricing on such items as hotel rooms, airline tickets and menu selections at restaurants, as the economy re-opens, these increases will quickly anniversary and are unlikely to be sustained
- Labor productivity is picking up nicely and if this is sustained, companies can increase wages to drive demand without the need to raise consumer prices in order to maintain profit margins
- The key driver of CPI…rent inflation…is actually decelerating so key sustained inflationary pressures are not significant; headline concerns are over-stated and more temporary in nature
In fact-based contrarian fashion, we remain positive regarding equity returns in 2021. Talk of bubbles is overblown and not supported by the data in our view. The rare combination of an accelerating economy, rising earnings growth, handsome stock price momentum, broad leadership across sectors, low interest rates and tight credit spreads rarely describe conditions of a market top. Corrections are short-lived and followed by moves to higher highs. That’s what we expect and are positioned accordingly. Stay tuned!
2Standard and Poors & Bureau of Economic Analysis
The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s and is comprised of 500 companies chosen for market size and industry group representation. 10 Year US Treasury Yield Curve Rates are interpolated by the Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. Individuals cannot invest directly in an index. This commentary is limited to the dissemination of general information pertaining to Mariner Wealth Advisors’ investment advisory services and general economic market conditions. The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. As such, the information contained herein is not intended to be personal legal, investment or tax advice or a solicitation to buy or sell any security or engage in a particular investment strategy. Nothing herein should be relied upon as such, and there is no guarantee that any claims made will come to pass. Any opinions and forecasts contained herein are based on information and sources of information deemed to be reliable, but Mariner Wealth Advisors does not warrant the accuracy of the information that this opinion and forecast is based upon. You should note that the materials are provided “as is” without any express or implied warranties. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
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