“Keep Calm and Carry on” #8
December 31st is taking on a lot of significance this year. It is an artificial deadline, but it is also an opportunity to take stock of the past as preparation for the future. This year we seem poised between our natural tendency for hopefulness and our innate human bias to emphasize the negative. Both are necessary for survival. Both are front and center in today’s environment.
The negatives we know. Social unrest, pandemic, economic dislocations all loom large in our consciousness. Personally, we have had to deal with isolation and disruption of our daily patterns and social interactions. From an economic standpoint the financial stresses start with unemployment and move through business shutdowns/slowdowns to fears of bankruptcy. Will the current surge in COVID-19 cases return us to the depths of April? Will unemployment drive bankruptcy and homelessness?
The positives we sometimes underestimate. The recent “stimulus” package with its income supports, is less than what many economists have indicated is necessary, but we should not forget that the total fiscal supports have totaled more than $3.5 trillion and it has been pumped into the economy in an unprecedentedly short time frame. There are people who will fall through the cracks, but this should help avoid the most dire effects on individuals and the economy. Personal bankruptcies are actually down. A moratorium on evictions will provide a chance for those at risk to recover.
Unemployment figures have improved from the depths but still the number of unemployed, underemployed, and leaving the work force represent a lot of hardship and underused human potential. In periods of extended unemployment, the concern is that the long term unemployed will lose skills undermining their return to the workforce. But 60% of the jobs lost are in virus-sensitive industries. When the virus is over, most of those jobs should come back.
The Federal Reserve acted aggressively to shore up financial fundamentals. Through various lending facilities they have supported the credit markets and borrowers, large and small, public and commercial. They are committed to keeping rates low even as the economy improves. This has the dual effects of supporting the economy and the stock market.
What might all this mean for the markets? If the economy snaps back, there may be some upward pressure on interest rates offset by Fed policy that will be working in the opposite direction. If it does not, we will continue in this low-rate environment. Either way returns on fixed income are likely to be muted. Fixed income continues to function in portfolios, just not as an income source, but as a risk reducer.
For equity, the expected environment is positive. Most expectations post-vaccine 2021 call for an improving economy, growing corporate earnings, lower unemployment, and low interest rates. This is a strong backdrop for stock prices. In fact, if the economy improves as expected the stock market strength that has been fairly narrow should broaden from the technology, digitalization, e-commerce driven market that we saw for much of the last nine months.
The question on many investor’s minds is valuation. Are stock prices so high that they have nowhere to go even in a supportive environment? One of the economists that I love to hate is Robert Shiller. He is known for his CAPE index which looks at stock prices based on the last ten years real earnings per share. I do not remember a time when he thought that stock prices were undervalued. One of the criticisms of this approach is that it does not consider interest rates. Low rates make stocks look more attractive. (They also raise valuations by lowering the discount rate at which earnings are valued.) He now has a new index, ECY, that does adjust for interest rate’s effect on equity valuations. This puts US equity valuations at a reasonably attractive level and at even more attractive levels for other markets.
In 2020 Keeping Calm took fortitude. Carrying On took persistence. In our personal lives most of us have stories we will tell of both strength and adaptation and, for too many of us, stories of sorrow. On a day-to-day level we cope with the current pandemic surge and look forward to the day when it will be our turn for the vaccine. The Solstice gives us hope for a return of daylight: the vaccine gives us hope for light at the end of the tunnel.
“There was never a night or a problem that could defeat sunrise or hope.”
-Sir Bernard Williams, FBA