High Level Commentary

MARKET PERFORMANCE-As Of February 28, 2021

Short-Term Positive:

-Government stimulus is increasing economic growth.

-Some of the stimulus dollars are moving into the markets.  This provides short-term investment demand to push prices higher.

-COVID-9 vaccines are bringing an end to shutdowns.

-Pent-up savings, pandemic constrained spending and pent-up demand should increase near-term economic growth.

-2020 Q4 earnings are coming in above consensus expectations and 2021 CY earnings are being revised upward.

Short-Term Negative:

-Asset inflation (both stocks and bonds) has pushed market prices above fundamental valuation levels.

-Consumer inflation is not reflected in current data but is likely to increase.

-The Federal Reserve’s monetary stimulus has kept interest rates low but it distorts markets by shifting investors towards risky assets.

-Valuation levels are expensive for stocks and long-maturity bonds.

-Speculative red flags include GameStop, Bitcoin, Tesla and the proliferation of SPACs.  This speculative demand is driven in part by increased retail demand and especially investors who are confusing gaming with investing.  Current speculative momentum could reverse quickly.

Rebalancing remains critically important to trim asset classes that have grown above your strategic investment objective and to add to asset classes that are below your long-term strategic investment objective.  For example, trimming large tech holdings with big gains over the last year, and adding to international.

Performance:  U.S. stock indexes moved up to record-high levels in February based on optimism with COVID-19 vaccine and lower levels of hospitalizations and deaths in the U.S. and Europe.  The positive news related to the rollout of vaccines shows that the market is pricing in better prospects for the economy and corporate earnings.  Small cap stocks have outperformed recently as the market rotated away from some of the tech darlings (Apple, Facebook, Alphabet/Google).  Small cap stocks are cheaper and have more earnings upside as the economy recovers from the COVID-19 lockdowns.  Small caps will also be strong beneficiaries when a stimulus bill eventually gets passed.  Emerging markets have also outperformed recently based on strong Chinese growth, improving earnings prospects, lower global interest rates and a weaker dollar.

Although bonds were positive in 2020, longer maturity bonds have underperformed in the last three months.  While fiscal stimulus is necessary as we face the COVID restrictions and lockdowns, there is a growing concern related to potential inflation and to huge government budget deficits.  Investors are less willing to accept historically low longer-term government debt, and this is pressuring long-maturity bond prices lower as yields move higher.

GameStop-GME gained 1625% during January and dropped -69% in February.  Retail investors drove the stock up as they purchased the stock and call options on the stock, forcing hedge funds with short positions to cover their short positions.  Investors with short stock positions essentially borrow stock and then buy it later to close out their positions.  Investors take short positions when they expect the stock to decline.  GameStop has been a favorite stock to short because it is a bricks-and-mortar video game store with declining revenue and profits.  Short positions on stocks can be lucrative if stocks decline sharply, but are very risky when stocks rise.  Retail investors used Reddit’s WallStreetBets, web site to coordinate stock and call option purchases as they encouraged one another to upset the Wall Street status quo.  This was described as a David and Goliath story.  Although many retail investors achieved huge short-term gains in January and have forced huge losses on the hedge funds with short positions, there is no fundamental reason to hold the stock on a long-term basis.  This was an example of social media promoting mob behavior and GameStop plunged 68.7% in February.

COVID19 and Positive Gains for Vaccines and Treatments:  The Pfizer/BioNTech and Moderna vaccines are being rolled out in the U.S., and Astra Zeneca/Oxford is being utilized in the U.K.  At this point, they are showing high efficacy rates at around 95%.   In addition, Johnson & Johnson completed its Phase 3 trials, and the FDA has granted Early Use Authorization in February.  The J&J vaccine is noteworthy because it requires only 1 shot compared to the others that require an initial shot and then a follow-up shot.  These are very encouraging results, and vaccine production is expected to increase significantly throughout 2021.  A key question remains regarding how well these vaccines work for the variant mutations first seen in the U.K. and South Africa.  Another question relates to how long the vaccines provide immunity before a booster shot might be needed.

In addition to the reports on vaccine development, treatments are also making progress.  Eli Lilly announced a treatment in November that provides a treatment for people in the earlier stages of the virus infection.  This drug appears to be able to keep people from getting worse and needing to be hospitalized.  This is particularly important as hospitals are currently operating at high capacity levels.  Regeneron has an antibody cocktail that is reducing viral symptoms and thus reduces hospitalizations and physician visits.  Gilead Sciences’ antiviral drug Remdesivir received FDA approval in October.  This drug shortens the recovery time for patients suffering from COVID.

Vaccines and treatments hold the promise of allowing the global economy to get back closer to normal.  Dr. Anthony Faucci continues to express optimism regarding vaccine and treatment approvals, but broad-based utilization still looks more likely by mid-year 2021.  The COVID-19 vaccine continues to be used to innoculate front-line health care workers and elderly who are at most risk to the virus.  Over time, the vaccines will achieve “herd immunity”, whereby the antibodies of the majority of individuals built up, either via exposure or vaccination, are sufficient to protect the remaining vulnerable people.

Virus resurgence-Although vaccines and treatments are making rapid progress, the U.S. and Europe experienced high levels of infections related to holiday travel.  President-Elect Biden has established a task force, but policy implementation will take time.  Meanwhile, the UK, Germany and France implemented strict restrictions and lockdowns.  As a result, European economic growth is at risk of a second downturn.  Until vaccines and treatments become widely available, broad-based testing and tracing needs to be expanded so virus carriers can be identified and isolated.

Markets have also reacted positively to President-Elect Biden and the prospect of additional stimulus.  Key goals in a Biden administration include plans for clean energy and infrastructure, raising taxes on high-income households over $400,000 and an increase in the corporate tax rate from 21% to 28%.  The tax increases are described as raising $2 Trillion over a decade.

U.S. Economic Statistics Remain Positive.  Economic statistics dropped precipitously due to the government-induced shutdown, but then rebounded well above consensus expectations.  More recently, however, economic reports are less robust but still remain positive.

-US Third Quarter GDP moved up 7.4% on a quarterly basis, compared to a -9.0% second quarter decline.  This was a reasonably good report, with continuing gains for consumer spending.

-Unemployment (at a 50-year low of 3.5% in February) spiked to 14.7% in April but has since dropped to 6.3% for January.  Although many workers have been called back to their jobs, this unemployment level is still at a high level.  In addition, the December jobs report was weaker than expected and it showed temporary furloughs becoming permanent.  Moreover, initial claims for unemployment insurance, a proxy for layoffs, remains in a stubbornly high range of between 700,000 and nearly 900,000.

-Retail sales for April declined 14.7%, the largest decline since 1992 when this data series was initiated. However, May retail sales jumped a record 18.3% on a month-over-month basis, well above the consensus expectation of 7.5%.  Retail sales were impacted by pent-up demand and government checks, but June was also up an impressive 8.4%.  Sales growth slowed in November and December, but January retail sales were up a strong 6.1%

-Industrial production advanced 0.9% in January.  This was a solid gain, but Industrial production is still down from the pre-pandemic February level.

-Housing has remained strong due to low mortgage rates.  The recent rise in interest rates may reduce the rapid growth rate in the future.

-The Leading Economic Indicators came in at a positive 0.3% in December, the eighth consecutive monthly gain.  Before that, the data was negative with March down 7.5% and April down 6.3%. These statistics point to the sudden, large shutdown of the U.S. economy caused by the unprecedented coronavirus pandemic, and then an encouraging uptick.

Two-Track Economy.  Although the U.S. economy is recovering, employment and overall economic activity remain well below pre-pandemic levels.  While manufacturing has rebounded significantly, the service sector continues to struggle.  Lower-income workers have been disproportionately impacted by service sector job losses, and this leads the characterization of a two-track economy.  This economy is also described as being “K-Shaped”, with some groups doing quite well and others trending downward.  There is a clear need for a targeted fiscal stimulus package and hopefully a compromise package can be structured now that we are past the election.

Market valuations remain rich.  At this point, markets are ignoring weak 2020 corporate earnings, and are trading on expected 2021 earnings.  Nevertheless, various valuation metrics (like Price/Earnings ratios) for 2021 are still elevated.  It is important to remember that valuation doesn’t predict short-term performance, but valuation definitely impacts long-term performance potential.  In other words, markets could continue to get move up on a short-term basis, but the longer-term performance might be a 5-7% average long-term return/year rather than the historic 10%/year return.

Corporate Earnings for the fourth quarter are expected to be down 2.3% and revenue is expected to be up 1.7% according to FactSet.  For all of 2020, FactSet sees corporate earnings down 12.1% and revenue down 1.3% compared to 2019.  Although earnings remain negative on a year-over-year basis, they are continuing to be revised upward.  Looking ahead, the Factset consensus for 2021 shows an 8.7% revenue gain and a 23.6% earnings gain compared to the COVID-19 impacted earnings drag in 2020.

For more detail see:

Markets & Economics

Market Performance

Valuation

Cornerstone maintains significantly more data and graphs than what is presented in this website.  Contact Jeff Johnson regarding specific data questions and comments.

Yahoo Finance link is helpful for daily market activity:  http://finance.yahoo.com/