One of our wittier clients recently commented that on midnight January 1st, it was the first time in history we all had hindsight that was 2020. Even Nostradamus could not have had the foresight to predict the magnitude of the Covid-19 pandemic, that oil prices would fall below zero, that shares of Hertz would significantly appreciate after declaring bankruptcy, or that pharmaceutical companies could develop multiple vaccines in less than one tenth of the time it has historically taken them to create just one. There were so many “unprecedented” events during 2020 that the use of this word now feels trite.
Financial markets behaved capriciously during the year with the S&P 500 surprisingly finishing up nearly 18% while concurrently the global economy noticeably declined. With the benefit of 2020’s hindsight, the large outperformance of the S&P 500 versus the economy last year was primarily due to the difference in the composition of the S&P 500 compared to the US economy. Apple, Microsoft, Amazon, Alphabet and Facebook combined comprise 21% of the S&P 500 but collectively generated 66% of its returns. However, compared to the US economy as measured by gross domestic product (GDP), the collective net income of these five stocks during the year represented only 1% of GDP. The S&P 500 is arguably now “top heavy” from the appreciation of its largest constituents. For example, Apple, the world’s largest publicly traded company based on its market capitalization, is valued at $2+ trillion making it worth more than all the constituents of the Russell 2000 Index, combined.
As we enter 2021, many remain cautious or understandably, afraid. There is currently $500 billion more in money market funds compared to pre-pandemic levels. 79% of the more than 500 institutional investors recently surveyed by Natixis SA do not expect GDP to recover to pre-Covid levels before 2022. Handgun sales increased year-over-year by 81% and personal savings rates are at decade highs. However, there have also been increasing signs of what John Maynard Keynes referred to as “animal spirits.” Margin loans or the use of debt to buy publicly traded securities is at all-time highs. Individual investors opened more than 10 million new brokerage accounts during 2020, a record. The volume of traded option contracts, risky securities that are levered to the change in price of an underlying security, were 48% higher than during 2019. Initial Public Offerings (IPOs) have started to party unlike any time since 1999 with more than half of these new issues being speculative, special purpose acquisition companies or SPACs. At the start of last year, Berkshire Hathaway held enough cash to buy Tesla, twice. Enthusiasm from Robinhood’s investment community and Elon’s Musketeers helped to drive Tesla’s share price up so much that at the end of the year it was the 5th largest publicly traded company in the US, making it larger than all of Berkshire Hathaway. Bitcoin, once referred to as “a charlatan attracting delusion that is likely rat poison squared” by Warren Buffett, arguably one of the greatest investors of all time, recently sold for more than $40,000, up from $7,000 at the time of his statement.
It is challenging to describe the current prices of most investable assets as inexpensive. The S&P 500’s price to earnings ratio is currently 31x. In 1990, a $5 million portfolio of investment grade municipal bonds could generate $362,500 of tax-exempt income annually; today, it takes $36 million to generate this much income. As a result, many investors that would like to buy bonds are no longer able to “afford” them. Technology now represents 38% of the S&P 500’s market capitalization but accounts for just 6% of US GDP and 2% of employment. However, the collective optimism of investors that is being reflected in asset prices has some merit. The Fed is expected to keep interest rates near zero until 2023 and to continue purchasing $120 billion worth of bonds each month until the economy is near full employment. The money supply has been growing at an annualized rate of 25% and while this would typically stoke broad inflationary pressures, to date, an historically high savings rate has resulted in the inflation of asset prices, not the real economy. During a time of extreme political polarization, Republicans and Democrats have worked together to pass multiple fiscal relief bills. With a so called “unified government” in 2021 and interest rates hovering near zero, these levels of fiscal and monetary stimulus are likely to continue unabated.
John Kenneth Galbraith once said, “the only function of economic forecasting is to make astrology look respectable.” Having provided this disclaimer, the 2021 consensus forecasts are for GDP growth of 4% and for the S&P 500 to gain 7.4% and there do seemly remain some areas of potential opportunity for investors. As the pace of vaccinations improve and fiscal & monetary stimuli increasingly flow into the economy, small and medium sized companies should start to noticeably recover and with interest rates close to zero and likely to stay there for some time, quality dividend paying stocks seem relatively attractive. It is likely the New Year will present more than its fair share of challenges but the mere changing of the calendar to 2021 does makes it seem likely that it will be an improvement over an unprecedented 2020.
Ted E. Furniss, CFA – January 2021
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