Morning Jog

Crazy Train

After that rollercoaster of a year, 2021 could not get here fast enough. But the relief from seeing the calendar turn was fleeting. We woke up on January 1st to the persistent third wave of the pandemic, renewed lockdowns and recognition of the tough slog towards regaining normalcy.

And just when political noise appeared to fade, it came roaring back this week when a ceremonial day for Congress to rubber stamp the electoral results was interrupted by the violent attack on the Capitol. It was a surreal and shocking scene, exposing our divisiveness for the world to see.

Years of normalizing “Alternative Facts”, a seemingly innocuous phrase uttered four years ago, but a notion since embraced at the highest level of government and amplified in the media information bubbles, led us to this moment. Perhaps this moment and the unifying condemnation is what is needed to walk us back from an even larger crisis and be the wake-up call for true leaders to step up.

The equity markets greeted the chaos in D.C. with a shrug, giving up some of the day’s gains, but still ending up on a positive note and of course with the obligatory record highs in Bitcoin and Tesla¹.

Market attention was not on the fumbled revolution, but the resolution of Georgia’s runoff elections, with Democrats winning both Senate seats and gaining control of Congress. While single party control of both branches historically has not been the favored outcome for the markets, the positive reaction this week makes sense.

The slim margin of control by the Democrats, with the Vice President casting a tie-breaking vote in the Senate and a narrow majority in the House, implies that every vote will be needed to pass legislation. Moderate Senators will not back policy agenda that veers too far from the center, but the ability to pass much needed legislation to aid the economy is still there. An effective unified government is a good thing in time of crisis and the market clearly appreciated this “fiscal goldilocks” scenario.

We will see the third major stimulus package soon, which Goldman pegs will come with a $750 billion price tag, and include additional checks, extension of unemployment benefits and aid to states and local governments.

The new stimulus along with the continuing vaccine rollout means that the recovery will be sustained and with Central Banks keeping the monetary spigot open, the path of least resistance for the equity market looking out a year from now is higher.

Resolving the health crisis paves the way for a broader recovery, as the service economy, travel and entertainment industries rebound. There is substantial pent-up demand to dine out, travel, attend sporting events and concerts. And unlike every other prior recession, there is a savings glut to fuel spending when things reopen.

Amazingly, despite record-high unemployment levels, household savings increased by $1.56 trillion last year. Personal income was higher, as higher-paying jobs shifted to remote work and government transfers provided massive support for many of the unemployed. And spending, particularly on services saw a sharp decline.

The near-term challenge for equity investors is twofold: optimistic sentiment (evidenced by rising margin debt balances and an insatiable appetite for IPOs) and stretched valuations.

The S&P is trading at 22x forward earnings – a multiple that historically indicated stagnant returns for the subsequent five years. However, aggregate metrics can mask the dispersion between companies comprising the index.

The index is heavily weighted towards technology and consumer names that not only maintained, but grew earnings, at a time when earnings growth was scarce. Understandably investors crowded into the names in search of safety and growth, pushing up their valuations. The dispersion is clear from the chart below, where the top 10 stocks in the index are trading at a wide valuation gap to the remaining ~490.

As the economic recovery takes hold and other sectors start to see earnings improvement, markets will broaden out beyond FAANG. We started to see these shifts post vaccine announcements last fall, with value sectors of financials, materials and energy catching up, a trend we expect to continue this year.

If there is one investment lesson from 2020, it is to be prepared for the unexpected: the market will continue to surprise bulls and bears alike. So, we will stay humble, but hopeful for a bright year ahead.

Enjoy your weekend.


1) Tesla.