Monthly Outlook: August 2021
Summer is in full swing, and the economy is booming! Here in Aspen, it’s hard to find parking, get a reservation, or find tickets. I hear it’s the same from coast to coast. Thanks to vaccines, the COVID crisis has subsided and pent-up demand for fun and adventure has been unleashed. It feels like people are cramming two summers of fun into one. Additionally, both the Federal Reserve and Congress have poured unprecedented trillions of dollars of stimulus into the economy to boost the recovery. Although it could be (and should be) argued that the stimulus was inefficient and sometimes misdirected, the effect is clear. The economy has certainly recovered and by all measures is back to pre-COVID 2019 levels, or better. And, importantly to us and our clients, stock, bond, and housing markets have fully rebounded and then some, thanks to all the stimulus programs. The questions that have arisen are: If the economy is so strong, why is stimulus still needed? When will the Fed taper and fiscal stimulus expire? And, Is the economy strong enough on its own merit to withstand the withdrawal of stimulus? The Fed created “the stimulus bubble” and now, all eyes are on the Fed to see if they’ll be the ones to pop it. The Fed’s annual symposium will be held in Jackson Hole, WY on August 26-28th, so maybe we’ll know soon enough.
As Good as it Gets?
As we close out July, most companies have reported their 2nd quarter earnings. And, as expected, earnings have rebounded strongly especially compared to the 2nd quarter last year when the economy was locked down due to COVID. Investors and analysts get excited about these impressive year-over-year results and then extrapolate continued outperformance into the near future. But although earnings will likely continue to grow, they surely can’t sustain the recent growth rate of the shut-down and recovery bounce. Just consider these numbers: S&P500 earnings were $139/share in 2019. Earnings sunk to $94/share in 2020 during the recovery. That’s understandable. Through 2nd quarter (now), earnings are back to $128/share. That’s understandable, too. But according to Standard & Poor’s research, Wall Street analysts now think that S&P500 earnings will continue to grow to $174/share by year-end 2021 and grow further to $194/share by year-end 2022. That’s a high bar for companies to clear. Already we see companies trying to talk down these lofty expectations.
Valuations are at 90-Year Peak Levels
Investors have embraced the recovery story and earnings rebound, driving prices higher. As a result, valuation levels have never been higher. Valuation metrics like Total Market Cap to GDP, Price to Earnings, Price to Sales and others are at 90-year peak levels, higher than previous peaks of 2007, 2000, and 1929. In other words, the lofty earnings expectations are fully priced in, and maybe then some. At this point, the economy must continue to rapidly recover, and the earnings must continue to grow, or the market could become disappointed. So far, recovery and growth are indeed happening, and stock, bond, and house prices grind higher. Yet, given extreme valuations, it’s only sensible to be vigilant for any catalyst that would upset the recovery and spark a correction. The most likely catalysts today are a resurgence of COVID or stimulus tapering by the Fed.
Investing with a Safety Net
Markets have been very good to investors, really, since the bottom of the Financial Crisis of 2008. Sure, the COVID crisis and economic shutdown caused a brief market crisis, but that didn’t prove to be long-lasting. Today, the economy is back on track, earnings have recovered, stimulus continues, and market prices have climbed to peak valuation levels. It would be easy to be complacent. But it’s for exactly these reasons that we remind investors that this is the classic setup for a reversal. Every investor needs a safety net in place – now. It’s like the advice to buy umbrellas on a sunny day. We use trailing sell-stop orders to limit downside risk. There are other techniques for protection, but it’s sensible to have something in place now. We intend to keep making money for now, but we know how to avoid the big loss whenever the time comes. Remember, the ultimate goal of investing is to make it…and keep it!