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.
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.
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).
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!
History doesn’t repeat, but it often rhymes, and sometimes it “reflects!” Forty years ago, the U.S. was at the tail end of its worst inflationary spiral in history and inflationary fears permeated the behaviors of consumers, businesses, politicians, and policy officials. Here in 2020, after more than a decade of disinflation/deflation, chronically falling/negative yields, and weak/contracting economic growth, economic stagnation fears are rampant and it is like watching a mirror image of 1980.
As the S&P 500 reaches a new high, investors are increasingly alarmed by its valuation. And rightly so! Nearly every traditional valuation measure suggests the stock market is trading near all-time record levels. If conventional valuation models are accurate, the stock market appears to have very little upside potential and, ultimately, considerable downside risk.
Last Friday’s employment report illuminated that the U.S. economy continues to recover from its pandemic-induced shutdown. Indeed, the Atlanta Fed GDPNow U.S. real GDP forecast for the current quarter is an astounding 20.5%! Bouncing back from the worst ever post-war economic collapse, the U.S. is headed for some gaudy economic numbers in the contemporary quarter. The question facing investors is what are the implications for earnings results next year?
While the S&P 500 is still off by about 5% from its all-time high and is essentially flat since year-end, it has surged by 45% from its March bear market low. For many, its amazing recovery in the face of an ongoing pandemic and considerable evidence of strife on Main Street suggests caution is warranted.
This article has been retracted.
Of the many extraordinary events that have occurred so far in the contemporary crisis, U.S. economic policy is near the top of the list. Monetary and fiscal authorities have responded to this pandemic faster, and with greater force, than ever. Chart 1 introduces the U.S. Economic Policy Indicator, defined as the excess pace of money-supply growth above economic activity, plus the level of federal-deficit spending as a percent of nominal GDP.
The Technology sector now comprises about 27% of the total S&P 500 market capitalization, its highest representation since it peaked near 34% during the 2000 dot-com bubble. Moreover, there is growing concern about the outsized impact of the popular FAANGs and the fact that so few companies are increasingly responsible for much of the overall stock market’s ongoing recovery
Value stocks and growth stocks have recently created angst for investors. Value investing reflects an entrenched, losing momentum and the growth style increasingly appears like a bubble in search of a bust. This isn’t exactly a new trend—growth has been besting value for much of the last 15 years, but it has accelerated mightily since year-end, escalating concerns among both value and growth investors.