Monthly Outlook: July 2021
Confidence and exuberance are the watchwords of the day. And we’re as confident in the U.S. economy as everyone else. Thanks to science and vaccines, the COVID pandemic seems mostly behind us, and the economy feels as open as can be. Every restaurant and store seem crowded, and every airplane that I’ve been on is filled. Jobs are being created and the unemployment rate is steadily dropping. Stocks have fully recouped their COVID pandemic losses and added 25% more. House prices are spiking higher, up 14% over the past year, according to the Case-Shiller Index. Of course we’re all exuberant; happy days are here again, right? Yes, and no.
It’s important to differentiate the mindset of Main Street vs. Wall Street, if you will. Main Street focuses mostly on the present, and on their own personal welfare. If individuals have a good job, good health, a little money in the bank, and freedom, they’re right to feel confident. That’s where we are today. The Consumer Confidence Index is at 127, near a 20-year high (range of 30-130). So, when you’re partying again on Main Street with your friends and neighbors, it’s obvious why the summer of 2021 feels so good.
Wall Street, on the other hand, focuses on the future. We saw evidence of this in April of 2020, in the depths of the COVID pandemic. While COVID was still raging and the economy came to a screeching near-halt, the stock market bottomed in March 2020 and then started a dramatic rebound higher, anticipating better times ahead. The time to buy on Wall Street was when Main Street was its bleakest.
Wall Street May Be Too Exuberant
Investors may be too exuberant today and have driven up asset prices past their fair values, using historical metrics. To be very clear, that does not mean asset prices (stocks, houses) will correct imminently. It just means that stocks are priced for perfection and the underlying fundamentals must catch up to these lofty expectations, soon. If any catalyst occurs that casts doubt upon these lofty expectations, analysts will downgrade their estimates and that could cause a stock market correction. But until a catalyst comes along, it’s onward and upward! Remember, an over-valued, over-extended, and over-exuberant market (like today) can stay that way for a long time. Valuations are terrible for short-term market timing. But valuations are excellent for 10-12 year forward predictions and today’s valuations suggest a flat, or negative, average annual return for stocks over the next 10-12 years. Really. At a similar valuation peak in 1929, it took 25 years to recoup severe losses. At the 2000 valuation peak, stocks took 14 years to recoup 50% losses. And after the 2007 valuation peak, it “only” took 11 years to recoup 50% losses. Again, I am not saying a severe correction is imminent, but there is certainly risk and potential for some downside at some point over the next couple of years. The point is to have a sell strategy in place NOW, in case the current peak expectations don’t materialize. We have that with iFolios.
Here is a good example of peak expectations: Standard & Poor’s reports that S&P500 earnings were $139 in 2019, pre-COVID. They dropped to $94 in 2020 during the pandemic. Post-pandemic, the analysts expect $175 in 2021, a 25% increase over pre-pandemic 2019 earnings. And the analysts expect that earnings will continue higher in 2022 to $195. Really? How? The NBER calculates that the economy has recovered 97% of its pre-pandemic level. So, how are earnings going to be 25% higher this year and another 12% higher the following year? These peak expectations are fully priced into the stock market today. Let’s hope they materialize.
How to Invest During Peak Expectations
The key to managing wealth over time is to make it, and keep it. Today, stock markets continue to trend higher based on real economic recovery combined with lofty expectations. We’re in “make it” mode and we remain invested. At the same time, stocks are very over-valued and risky if peak expectations aren’t met. It’s critical that investors manage risk, more than ever. We use sell-stop orders and a strict sell discipline that will keep our investors safe from “the big loss.” This is no market for buy & hold.