Some recent academic research has called into question the existence of the “size premium,” i.e., the tendency for small cap stocks to outperform large cap stocks. Leading up to 2020, U.S. large caps had outperformed U.S. small caps for five of the previous six years, which would superficially seem to support this point. In addition, since the start of the pandemic, much has been made about winners winning, big getting bigger and little guys bearing the brunt of the punishment. While there is a lot of truth to these statements, smaller publicly traded firms (which aren’t small relative to the average U.S. business) had largely kept pace with the big boys through the summer months of 2020. Since the November elections, however, when the reflation trade began in earnest, small caps have outperformed large caps by more than 20%. The risk-on appetite from investors and the rotation towards cyclical stocks has been a boon for these smaller stocks.
As the Biden administration takes the reins of the U.S. government, it has been handed the same major problem that has plagued our country for nearly a year: combatting the biggest global health crisis in modern history. Although President Biden has a long list of agenda items, nothing matters more for the U.S. economy and the wellbeing of its citizens than getting the COVID-19 pandemic under control. This is also true for capital markets. Stimulus has and will continue to be a huge support underpinning markets, but getting COVID in check by late second or early third quarter has been essentially priced into risk assets for some time.
Manufacturing activity chugs along, consumers take pause, as the incoming administration readies a new round of stimulus
U.S. manufacturing sectors continue to show signs of improvement with encouraging readings in the December ISM Manufacturing indexes, the January Empire State Manufacturing Survey and rail shipments. Additionally, December’s 1.6% surge in U.S. industrial production, and rise in capacity utilization to 74.5%, point to continued manufacturing strength in early 1Q21.
It happened again, just like it did in 1999. A friend told me that he was a genius for buying Tesla and wished he had bought more, so he could be hailed as one of the “Tesla-Millionaires.” Oh well, but wait, he had a new, even better idea — Bitcoin! Who would have “thunk it”? I wouldn’t be so jaded if I hadn’t managed money through these manias before. In fact, the last time my friend was so euphoric about his stock picking ability was in 1999 and the next 20 years have been one loss after another to the point where he gave up on picking stocks “forever,” that is, until now. Hey, I make no bones about it, 2020 was a fantastic, magical, lovely year for stock pickers; it’s just not so lovely when it ends. Back to the market on Monday: it actually went down one day in a row — what is up with that? We need more stimulus from the government and the Federal Reserve so that doesn’t happen again.
Yesterday the yield on the benchmark ten-year U.S. Treasury note surpassed 1% for the first time since the pandemic kicked into high gear and the U.S. Federal Reserve began its unprecedented, aggressive response. At the same time, inflation expectations have been climbing, leaving real yields decidedly negative, which is a good thing for stocks. The spread between the ten-year T-note and the three-month T-bill also has moved higher and is now nearing 1%. One doesn’t need a degree in mathematics to ascertain that short rates must be near zero, where we expect they will remain for the foreseeable future. This curve steepening is a reflection of an improving economic outlook and is welcome relief for financials, in particular banks, whose core business is based on short-term borrowing and long-term lending. As the outlook for economic growth gets better, so too should the performance of financials and other cyclical sectors, which generally have lagged over the last several years but are leading the charge in the first few trading days of 2021.
Georgia Run-offs, Surging COVID-19 Infections and Vaccine Distribution Snafus Rattle Markets to Start the Year
Control of the U.S. Senate and the fate of President-Elect Joe Biden’s agenda rests in the hands of Georgia voters. Although the historically conservative state went to Biden this year, the consensus immediately following November’s results was that Republicans would hold at least one seat, and thus maintain their majority. Since the start of December and following record-breaking fundraising in which Democrats raised over $210 million and Republicans raised over $135 million,1 pols and prediction markets have both shifted to what is now seen as essentially a toss-up. Should Democrat candidates prevail, count on a flurry of spending and left-leaning policies to be rolled out over the next two years. Markets have already moved to price in this possibility with inflation expectations climbing to their highest level since 2018.
U.S. initial jobless claims rose to 885,000 from 862,000 a week earlier. After steadily trending down from a high of 7 million near the end of March, the labor market is cooling as COVID-19 cases remain elevated heading into the winter season and the government imposes new restricts on activity. Although vaccines are being rolled out, most economists expect hiring won’t accelerate until Q2 2021. November retail sales also came in softer than expected at -1.1% and October’s results were revised down to -0.1%, from 0.3%, ending a streak of five straight monthly increases. November’s weakness was broad-based, with the largest declines in apparel (-6.8%), food and beverage (-4.0%) and electronics and appliances (-3.5%). December’s Flash Markit PMIs declined for both manufacturing (-0.2 pts) and services (-3.1 points). Housing continues to be a bright spot with housing starts and building permits coming in better than expected. However, the NAHB Housing Market Index, a measure of homebuilder sentiment, came in slightly worse than expected.
Third-quarter earnings for S&P 500 companies are essentially in (one company remains). Overall, the index posted year-over-year (YoY) revenue and earnings growth of approximately -1% and -6%, respectively. Roughly 85% of companies reported earnings that were better than expected, which is above the long-term average of 65% and the prior four-quarter average of 73%. There was significant variation across sectors. Excluding energy, earnings only declined by about 2%. Healthcare and technology have held up well throughout the pandemic, with eight out of ten healthcare sub-industries posting higher earnings than they did a year ago.
Special purpose acquisition companies, or SPACs — not Spock as in Star Trek — are shell companies designed to raise capital in order to acquire unspecified target companies at some future time. SPACs are listed on the stock exchanges via initial public offerings (IPOs) of stock. When a SPAC buys a target company, the SPAC’s public listing, allows the target company to go public faster, and with fewer regulatory hoops, than going through a normal IPO process.