Daily Global Perspectives

The ten-year U.S. Treasury yield ended 2020 at 0.91%. As of February 23, 2021, the ten-year yield stood at 1.38%. That represents a 51% increase in less than two months; with over a trillion dollars of fiscal stimulus coming, some investors are worried that inflation may get out of hand.

Houston’s biggest problem this week has been lack of energy. Come again? How is it that a mega oil-rich region has an energy problem? Like the rest of Texas, Houston lost electric service when the State power grid shut down on Monday, in the grip of a rare cold snap. Some were quick to blame the loss of power on windmills that iced up, but windmills supply only 10% of Texas’ winter capacity; frozen pipes at gas- and coal-fired generation plants took a much larger toll on the electricity supply. The Texas grid didn’t fail because it lacked diversity among its energy sources, it failed because Texas wasn’t prepared for cold weather. This is a different sort of non-diversification, which can sometimes affect investment portfolio planning: failure to take into account the full range of possibilities that might affect outcomes.

The U.S. dollar has fallen approximately 13.22% since its peak at the height of the recession last March. The coordinated responses of the Federal Reserve, cutting interest rates to 0.00–0.25%; and Congress, delivering trillions of dollars in fiscal stimulus; contributed heavily to the risk-on environment and led to this steep decline in the U.S. dollar.

The only solution to U.S. debt is and always will be economic growth. Why is economic growth the only solution? Well, good question. The only other alternative to reducing debt is to reduce spending, or how about – no forget it, if I said it, it would be heresy. OK, here goes, “to actually pay the debt off, even partially.” LOL, I was kidding – let the party continue, let’s spend even more. Well, that is exactly what is happening: spending more at an accelerating rate — a massive, accelerating rate. OK, I get it, in the bear market of 1Q20, triage was the order of the day; the trillions of dollars the Federal Reserve used to support bond prices and the trillions of dollars of fiscal spending was arguably needed. But one year later, with vaccines in hand, more debt is not the answer – I believe economic growth is the only effective weapon, but it is being overlooked.

Economic growth is quickening, monetary policy remains highly accommodative with no sign of turning, fiscal expansion is continuing, corporate earnings are significantly exceeding expectations and COVID-19 infection and vaccine data are improving.

Equity markets have had a good start in 2021, with the S&P 500 index up 2.7%, the S&P Midcap index up 6.2% and the standout, the S&P Smallcap index, up 10.2% YTD as of this writing. This is a result of the view that more economic growth is to come from increasing vaccine distribution, continued easy monetary policy from the Federal Reserve and the expectation of at least $600 billion more in fiscal stimulus. This has led to record low cash balances among mutual fund managers — balances now stand below 2% — and P/E ratios over 30 for major U.S. equity indexes. Investors may compare today’s low cash balances and elevated to PE ratios to the late 1990s, but there are important differences to note between then and now.

Fourth-quarter 2020 earnings for S&P 500 companies are coming in much better than expected. At the start of the year, 4Q20 earnings were forecast to decline by 10.3% year-over-year (YoY). Now, with about 40% of companies having reported, consensus estimates are for earnings to decline just 1.2%. Positive earnings growth is being driven by technology, financials and materials stocks, while the energy, industrials, consumer discretionary and real estate sectors continue to be drags. Except for real estate, all sectors are surprising to the upside; and it now appears possible that 4Q20 earnings growth could flip positive.

It is getting serious now. The big boys, AKA hedge funds, are getting crushed by this stock market mania. It may just be karma that these hedge funds that take advantage of the little guy are getting schooled by a herd of little guys. The stock in this instance, Gamestop, represents a mania on steroids. This morning was an outlier, though, when my 15-year old daughter asked me a couple of revealing questions. The first was “Dad, have you ever heard of the stock A-M-C”? I said “yes,” the stock that went from $2 to $20 practically overnight, a measly 1000% return in a few weeks!

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.