January Investment Comments
As we wrap up 2020 it is worth highlighting what a roller coaster year it was for the market. Midway through December the S&P 500 has advanced more than 13%, a result that appeared highly unlikely during late March when shares fell sharply on COVID-19 fears. However, the market is forward-looking and global support in the form of fiscal and monetary stimulus has helped drive markets higher since the spring. Currently, the prospect of further stimulus combined with the fastest development of a vaccine ever recorded has boosted investor optimism and provided hope that a return to a more normal environment is on the horizon.
While several vaccines are on the way, the U.K. was the first country to authorize the Pfizer-BioNTech COVID-19 vaccine, starting distribution on December 8th. U.S. health regulators authorized use of the same drug on December 11th with the first vaccinations taking place December 14th. Initial supplies of the vaccine are limited, but production is expected to increase meaningfully over the next several weeks. Pfizer shipped out three million doses initially with an expectation of 25 million doses available in the U.S. by yearend. Health workers are first in line for vaccinations followed by other higher-risk populations. Americans are expected to broadly be able to get the vaccine by the end of March.
This comes none too soon, as COVID-19 infections, hospitalizations, and deaths are hitting records in the U.S. In response, states and municipalities are imposing new restrictions on activities, and this is showing up in the economic data. Claims for unemployment benefits are growing, recently reaching the highest level since September, though well below the historic peak achieved in March. In November, the Labor Department reported employers added just 245,000 jobs, well below expectations and down from 610,000 jobs in the prior month. This represented the seventh consecutive month of gains at a slower pace. At November’s pace of growth, employment would not return to pre-pandemic levels until 2024. The unemployment rate in November was 6.7%, down slightly from 6.9%. However, the decline was driven by especially unfortunate factors, as labor force participation declined to 61.5%, up from the lows in April but near the lowest level since the 1970s. This is possibly due to the lack of attractive job prospects or a reluctance to work due to fears regarding the virus.
Consumer spending, which accounts for more than two thirds of U.S. economic activity has been fairly resilient, increasing 0.5% in October versus September, the most recent data available. This was the sixth consecutive month of improvement, but the weakest increase since April. There is some concern that the rate of growth for consumer spending could continue to decline in coming months given many government support programs have expired.
Fears of an economic stall have led to calls for further stimulus. A bipartisan group of lawmakers is working on a potential $908 billion aid package. While both parties appear generally in favor of additional stimulus to help bridge the gap until the economy more fully opens, there continues to be disagreement over liability protections for businesses as well as provisions for state and local aid. It is possible the stimulus proposal will be broken into two parts: a main bill covering state unemployment benefits, aid to small businesses, and other items, and a possible second bill addressing state and local aid and liability protections.
In its December meeting the Federal Reserve is widely expected to approve new language specifying that the $120 billion per month in debt purchases launched at the start of the pandemic will continue until the recovery meets certain conditions. This change would signal the Fed intends to continue its purchases over a longer time horizon versus its current stance that purchases would continue “over coming months.” A change would complement the Fed’s pledge to keep interest rates close to zero until inflation is on track to exceed 2% and the economy reaches full employment.
Yields on the 10-year Treasury are hovering around 0.9%. This remains low on a historical basis, but yields have rallied modestly since earlier in the year due to optimism about an economic recovery. Corporate bond yields are also at or near historic lows. Given the supply of inexpensive capital, growth is at a premium. Companies demonstrating good growth with large addressable markets are experiencing optically high valuations. This is justified if these companies can fulfill their promise by capturing a significant portion of their potential markets. However, it appears the market is assigning high multiples to a wide swath of companies meeting this categorization. This looks to us like it underestimates the difficulty of achieving market dominance. Undoubtedly, some will be successful while many others will serve as tomorrow’s cautionary tales.
Investor appetite for these types of companies was evident in the recent IPO performance of DoorDash and Airbnb, which jumped 86% and 113% respectively on their first day of trading. These companies are trying to capture the local food delivery (DoorDash) and alternative accommodations markets (Airbnb). Some have pointed to echoes of the dot-com bubble but there are key differences. First, current IPOs are generally backed by better established companies with demonstrated success. Second, current monetary policy is far more accommodating than in 1999, when the Fed began raising rates mid-year and continued to do so until the market fell off in early 2000.
Aided by historically low interest rates, overall market multiples remain high. According to FactSet Earnings Insight, the forward P/E ratio for the S&P 500 is nearly 22x, above the 5-year average of 17.4x. Clearly, earnings continue to be suppressed by pandemic-related headwinds, though those should wane as we progress through 2021. Earnings are expected to decline nearly 14% in 2020, marking the largest annual earnings decline since 2008. In 2021, projections are for nearly 22% earnings growth. The 2021 projection represents a welcome return to something better approximating normalcy and an approximate 5% increase over non-COVID-impacted 2019 results. It’s hard to argue with the market’s year-to-date returns in 2020 but we doubt many are reluctant to turn the calendar to 2021. Cue up Auld Lang Syne.
James M. Skubik, CFA