The Roaring 2020s
Market melt-ups can last a long time.
Today’s market reminds me of the Roaring Twenties. It didn’t end well. But bubbles can last a long time. A whole decade. And who’s to say we’re in one? “What equity bubble?’’ Fundstrat asks, noting since 2009, of $3.1 trillion retail inflows into financial assets, 94% went into bonds. Unbelievable times. This week, we witnessed the first storming of the U.S. Capitol since 1814, and the market made new record highs. “Tulip-like upside of historic proportions keeps me a strong buyer of the ‘Best Bit of Kit’ on the board.” “The setup for risk assets is so much bigger and more bullish than any runoff—keep buying.” These are just two ebullient comments among many from my Wall Street research services this week, not to mention numerous boastful calls from fully invested friends and family. In December 1996 Fed Chairman Alan Greenspan famously asked, “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions …?” The widespread interpretation was he thought valuations were too high. But it soon became obvious he was simply asking the question and wasn’t convinced stocks were too expensive given sustained low inflation. Now, when asked whether stock prices might be overvalued, Fed Chair Powell acknowledged P/Es are “historically high.” But he added that may not be relevant “in a world where we think the 10-year Treasury [yield] is going to be lower than it has been historically…” So, Bernstein concludes, he’s saying stocks are “not overpriced.” Welcome to the roaring 2020s.
Moderate Democrats in purple states and swing districts understand two Senate squeaker wins in Georgia don’t make for a “blue wave.’’ With their party holding a slim 9- to 13-seat majority in the House, they’re looking at the possible loss of 10 to 12 “safe” House districts simply due to reapportionment. The biggest population gains from the 2020 Census are in GOP-controlled Sunbelt states, where legislatures and governors are certain to do their gerrymandering best to ensure party gains. So, when it comes to big tax increases and big-ticket spending initiatives such as Medicare for All and the Green New Deal, it’s going to be a struggle to get moderate Dems on board. They saw in 2010 what happens in midterm elections when the governing party colors outside the lines. On the Covid front, it’s a race between vaccine deployment vs. case spread. The current 500K daily inoculation rate should ramp up as vaccine distribution and outreach widens. (If you’re frustrated about the slow rollout, consider this: Bank of America says at the current pace, it would take 3,000 years for everyone in France to get a shot!) This isn’t a foreign concept—the U.S. vaccinated around 170 million in the 2019-20 flu season. Yardeni likens the “Great Virus Crisis” to a world war, with the Fed’s allies the European Central Bank and the Bank of Japan. Their campaign to carpet-bomb the global economy and markets with cash has led to significant advances on the economic and financial fronts, with the MSCI All Country World Index closing 2020 at a record high.
More stimulus is on the way across all fronts, a powerful floor making it dangerous to be a bear. Wall Street expects further equity upside into late January-early February before likely consolidation and a potential rotational pullback—small-cap and cyclical value stocks have been leading and are near extreme overbought levels. Consensus sees any sell-off as muted and as an opportunity to add. Indeed, when trends are this strong—roughly 90% of stocks in the S&P 500 began the year in an uptrend, the best reading since 2013—pullbacks are usually buyable. With a high level of optimism embedded in the financial markets and the risk of groupthink among investors, even a minor negative surprise could be a catalyst. Cyclicals, for example, already have priced in a PMI in the high 60s, a level that could encounter turbulence if mid-winter Covid flareups hit. However, earnings forecasts keep climbing, leaving the average S&P year-end target of 4,035 hardly “bubblicious.” While it would be difficult to describe the price of any asset in the world as particularly cheap, Strategas Research thinks we may only be at halftime in a speculative cycle. It's one thing for stock prices to go up as interest rates fall, but it is quite another to see them go up as rates rise. Though the 10-year bond yield recently pierced 1%, the “not thinking about thinking about thinking about raising rates anytime soon Fed” is ready to step in if long yields increase too much. Free commissions, free money and presumably more free time provided the impetus for individual investors to open an estimated 10 million new brokerage accounts in 2020, a record. With a slim Democratic sweep showering stimulus to combat stubborn structural unemployment, but unlikely to legislate worrisome tax hikes, this melt-up could last for years. We are living Modern Monetary Theory.
- It’s still a V The ISM manufacturing index surprised in December, rising to its highest level since 2018, with new orders growing at their fastest pace since 2004. Markit’s survey hit a 6-year high, with the outlook component jumping above 70. The broad-based improvement suggests vigorous year-over-year (y/y) earnings growth in Q4. Elsewhere, November factory orders unexpectedly rose 1%, with nondefense capital goods ex-aircraft, a proxy for capital expenditures, up a seventh straight month.
- It's still a V The ISM’s separate measure of services hit a 3-month high in December vs. expectations for a decline, led by accelerating business activity and growth in new orders. The combined ISMs correspond to 4.2% annualized GDP growth. Markit’s services survey wasn’t as robust—it declined for the first time in three months on Covid closures—but continued to signal healthy expansion.
- A globally synchronous recovery Despite Covid restrictions, retail sales shot up in Germany in November and were surprisingly strong in the U.K. and Australia. A strong finish to the year in China has Evercore ISI predicting 8% real GDP growth there this year. Back in the U.S., ISI’s gauge of retail activity is near a record high, while a strong December lifted the Q4 average light vehicle sales rate to 2019 levels, with y/y light truck sales up 1.7%.
- Covid winter wave December nonfarm jobs fell 140K, not shocking given the 123K drop in ADP payrolls—the first decline since April for both. But an upwardly revised November put the 2-month total jobs number at +135K, and notably, average hourly earnings rose a better-than-expected 5.1%, adding to a stimulus-fed financial cushion that could abet spending in coming months. With the slowdown centered in the battered leisure and hospitality industries, it could take years for the labor market to normalize, suggesting any Fed hikes are likely years away. The roaring 2020s.
- Should we start to worry about inflation? Capacity strains are starting to emerge as manufacturing activity continues to accelerate. The ISM December report found backlogs accumulating at their fastest rate in 2.5 years, with prices surging to near record highs.
- Another reason for dollar weakness The trade deficit jumped an above-consensus $5 billion in November to a 14.5-year high of $68.1 billion. The goods trade deficit hit a fresh record high, while the services surplus slipped to its lowest level since August 2012.
Stocks over bonds? While the spread between 2-year and 3-month Treasuries is just 4 basis points, suggesting no Fed moves for the next two years, consensus sees the 10-year Treasury reaching 1.20-1.30% this year. But Strategas, noting consensus on yields is almost always proven wrong, thinks 2% may be breached. Such a move could be a big problem for bonds, not so much for stocks. Why? Because inflation expectations have been rising as fast as the 10-year yield, keeping implied real yields deeply negative. That’s bullish for stocks.
Commodities over stocks? Deutsche Bank observes the start of the last two decades marked a secular turning point in the relative value of stocks vs. commodities. In the 2000s, commodities were the winner. In 2010s, U.S. equities were. With the relationship between the pair as stretched as it’s ever been, and with more dollar weakness quite likely, are commodities the better play again?
Bitcoin over gold? JP Morgan thinks the speculative mania over bitcoin is getting a secular push. As they become a more important component of the investors' universe, millennials seem to prefer “digital gold” over the real thing. If bitcoin should be comparable to gold, that could take it to $147K. Incidentally, at more than $1 trillion, the market value of cryptocurrencies is now worth more than Tesla and Netflix combined. Just saying.