- Entering the New Year bullish, we bid good riddance to 2020, a year marred by an epic Bear Market and global pandemic.
- Left “tail risks” trigger furious Bear Markets with increasing frequency, and should be planned for in the investment process.
- A “bunker buster” of monetary and fiscal stimulus kept financial markets and the economy functioning, with more on the way.
- The Ten Fundamentals are based on the A-B-Cs... through J, and are a comprehensive outlook for the economy and markets.
- Fundamentals drive markets, not valuations.
We enter 2021 bullish and say good riddance to 2020, a year marred by a Bear Market, a global pandemic, supply-side shocks, and economic lockdowns the world over. What we learned - or better yet, affirmed - is that when confronted by systemic shocks, it is more important than ever to “stick to the plan”. In Global Perspectives, our plan follows a strict discipline to capitalize on the insight gained primarily by evaluating advancing corporate earnings, broadening manufacturing and of course, the consumer, aka - the gamechanger.
Recall that 2019 was the best year in a decade for the markets, fueling optimism as we were entering 2020, despite the warning signs. But while optimism was high in the markets, the Fed was more somber and kept its eye on those warnings. Starting in September 2019 the credit markets – short-term lending between banks – were severely disrupted and required massive Fed cash injections. However, this ended up stoking the markets while the mounting corporate weakness was disregarded.
A few weeks into 2020 and the Bear Market hit fast-and-furious. As a famous boxer once quipped, “everyone has a plan until they get hit in the mouth.” Those with weak plans were stampeded as the crowd rushed to the exits. Investors who had a plan but didn’t follow it - in retrospect- never really had a plan to begin with. But once the “P” word (pandemic) was uttered, markets crashed and particularly notorious was the week ending March 20, 2020 when:
- The S&P 500 dropped 15% for the week and 28% year-to-date;
- The Bloomberg Barclays High Yield Bond Index dropped 10.1% for the week and 18.1% year-to-date;
- Bond Market volatility reached the highest level since the Financial Crisis
- Sellers, who were all trying to raise cash at the same time, overwhelmed the $18 trillion U.S. Treasury market, exacerbating an all-ready bad situation that froze the credit markets.
- The Fed stepped in massively with trillions of dollars for REPO, QE and more.
Wait a minute, has this happened before? Yes. Was this the first Bear Market in a generation? No, it was the third Bear Market in 20 years. Did many “plans” factor in the possibility of a Bear Market? No. Well… why not? Because risk control is expensive, and the assumption - or hope - that the Federal Reserve will “save the day”, is much cheaper. There is a pejorative name for these Fed bailouts; it is called “moral hazard” because the expectation of bailouts causes ever more need for bailouts. Certainly, investors need a better plan than the proverbial “Fed Put”, not least because at some point the Fed will “run out of bullets”.
But in 2020, the Federal Reserve and Federal Government, by golly, did deliver – not with a bazooka – but with a “bunker buster” bomb of cash injections. To help the markets and economy recover from COVID-19 the Federal Reserve and Federal Government increased their balance sheets by $3 trillion and $4 trillion, respectively, the most in both of their histories. There is more to come, too, with another $1.5 trillion or so on deck. This is an unfathomable amount of money, and it is finding its way to Wall Street.
The bullish case is predicated on positive earnings growth in 2021 and the “bunker buster” stimulus. This potent cocktail’s impact on prices is unpredictable and positive. Most surely this triage was, and is, needed as states still have lockdowns in effect. But, if the vaccines work and America is reopened, then the markets and the economy would be awash in liquidity. High P/E ratios do not decide turning points, but they still matter and the risk of “mean reversion” is not an insignificant.
There is more though. The U.S. is currently in the most extraordinarily competitive business position it has been in for decades. Corporate taxes are at a historical low of 21%, the web of regulations have declined precipitously, and supply chains are coming back to the U.S. across all sectors including Healthcare, Industrial, and Technology. Add a phenomenal amount of infrastructure ready and able to be quickly turned back on then the seeds for fast growth have been sown. This is unequivocally bullish for the economy, jobs and the all-important consumer.