Paulsen's Perspective
An Economic Pandemic Divergence
Although COVID-19 has significantly impacted everyone, its economic wake has been unusually bifurcated compared to past crises. Since the pandemic requires social distancing, the recession and its aftermath have been concentrated disproportionately among “social and lower-earning” industries. This odd, if not unique, divergence in the economic fortunes of low and high-earning industries perhaps explains how overall real GDP, the unemployment rate, the housing industry, manufacturing activities, and other economic segments have managed to recover quickly and powerfully.
Looking Beyond COVID… ?
In Minnesota, we’ve lived through a lot of COLD Winters! Could we now be headed for another doozy? The clocks have already been turned back, shrinking the daylight as the sun comes up later and sets earlier. Old Man Winter has wasted no time bringing record cold temperatures in October and snow cover, reminiscent of January, here in early November.
Policy Poised To Tighten?
The frightening COVID-19 winter-wave has understandably intensified calls for additional action both by monetary and fiscal authorities. Indeed, if widespread lock-downs are again implemented, the economy will need another bridge of support.
VALUE Needs More CAPITAL
Since 2006, the value investment style has suffered its deepest and most prolonged period of underperformance of the entire post-war era. According to the total U.S. stock database from Kenneth R. French, during this nearly 14-year period, value has underperformed growth by an astounding 58% (4.3% per annum)!
Broad Economic Sustainability
With no new stimulus package and a resurgence of COVID cases, worries surrounding the economy’s durability remain widespread. While this morning’s job report certainly helped quell some of those fears, there is actually a broadening array of economic gauges portraying an expansion that is becoming self-sustaining with or without additional stimulus.
A Growth Bomb!
There is plenty to worry about of late. A record-setting wave of new COVID cases is threatening to curtail economic activities. If a “COVID Winter” overwhelms U.S. hospitals—leading to widespread lock-downs—economic growth could be significantly impacted. FAANG stocks are under pressure, sending the stock market to the low end of a three-month trading range.
COVID & U.S. Economic Momentum
Everyone is understandably concerned about the recent surge in COVID-19 cases. Outbreaks in the U.S. have risen to the highest level since the pandemic arrived. Now a primary concern for investors is, will it significantly slow momentum in the economic recovery?
Assessing The TREND
Trendline analysis is a useful tool for assessing valuation risk and upside potential within the stock market. Unlike conventional valuation tools, it does not directly compare the stock market level to its fundamentals. Rather, it appraises performance relative to time, which indirectly relates price to fundamentals. Why? As Warren Buffet regularly points out, “stocks rise in the long run” because, with a very high probability, economies grow.
No Stimulus… No Matter: An October Pictorial
Governmental powers are still trying to put together another economic relief package. However, despite the July expiration of unemployment benefits provided by the CARES Act, here, two-and-a-half months later, U.S. economic momentum is remarkably healthy.
Monetary Madness & Fiscal Folly!
The nation hollers for more economic stimulus! The President says we need more, the Federal Reserve Chairman agrees, Republicans concur, and Democrats think no one is advocating for enough. The screams for help are amplified everyday by the media. Supposedly, the economy is hanging on by only a thread, desperately waiting for more support.
An Inflation Play?
With monetary and fiscal policies both running full-throttle, many investors are considering inflation hedges. Some traditional favorites—commercial real estate and energy stocks—have several issues holding them back (e.g., COVID-19 and environmental concerns), even with higher inflation. Cash and Treasury Inflation-Protected Securities (TIPS) may keep pace with inflation but offer little more because yields are so low.
Has “OVER-Valued” Lost Its Bite?
As throughout the post-war era, valuation tools provide guidance for investors to assess whether the stock market is cheap, reasonably priced, or simply too expensive. That is, looking back over the post-war period, the lowest-valuation quartile typically produced higher future stock market returns than valuations stemming from the highest quartile.
A Distorted Signal?
For many, the stock market rally since March remains suspect. Its leadership has not broadened beyond new-era growth stocks to include economically sensitive cyclical sectors and small-cap stocks. Perhaps, though, leadership in this new bull market is more established than it appears.
Confidence In A Crisis?
The COVID-19 pandemic rages on, the economy is still officially in recession, almost 8% of the workforce is unemployed, and layoff announcements remain commonplace. Furthermore, downtown office buildings are uninhabited, many businesses are operating far below capacity (e.g., restaurants, hotels, airlines), and corporate profits are much lower than pre-COVID.
The Bulls Are On Main, And The Bears Are On Wall?
Wall Street and Main Street often appear at odds with each other. However, since they are both importantly tied to the economy, it seems reasonable that sentiment for each would typically be similar. In the long run, both would cheer a healthy economy, and neither would root for recession.
A Decade Of Strong U.S. Economic Growth?
Amid an ongoing pandemic, and after years of extremely subpar economic growth, few anticipate the possibility the U.S. economy could be headed for an era of much stronger growth. However, the accompanying chart illustrates a historical indicator that suggests the U.S. may be on the cusp of a prolonged period of healthy economic growth.
Time To “Broaden” Bets?
Broader stock-market plays beyond new-era technology and communications have been generally matching the overall S&P 500 since it bottomed in March. However, these more widespread market plays—including cyclical sectors, small caps, value stocks, and international investments—seem poised to take a more significant leadership role in this bull market in the coming year.
Low Yields Provide Rarified Air For Stocks!
Bond yields and earnings are both currently low.
During the post-war era, the stock market has done best when yields have been the lowest (despite the fact that low yields are often associated with poor earnings results). This is illustrated in Chart 1, which shows the S&P 500 average annualized total return and the frequency of negative monthly returns by U.S. bond yield quartiles (1950-to-date).
Wall Street Divorced From, ahem, “WED TO” Main Street?
There is a widespread, consensus narrative that Wall Street Bullishness is divorced from Main Street Fundamentals. With things so bad on Main Street, the only reason the stock market keeps rising is because of a steady, massive, and unprecedented supply of “Sugar” being provided by both monetary and fiscal authorities. Once the sugar stops, the narrative goes, the stock market party is bound to end badly!
Overreaction?
The emotional fallout associated with the COVID-19 crisis produced an unprecedented reaction—or overreaction—by businesses, consumers, investors, and policy officials, which could play a major role in shaping the economic and financial-market landscape in the coming year.
Subscribe to Paulsen's Perspective