VIDEO: Are Stocks About to Take the Elevator Down?
Here’s my video presentation for Monday, January 25. Below, I flesh out my analysis in greater detail.
Have you ever been stuck in a malfunctioning elevator at a great height? It happened to me a few years back and I can tell you, the experience was unnerving.
Investors could face a similar peril right now (metaphorically, that is). There’s an old Wall Street adage: The market takes the stairs up and the elevator down. That’s just a colorful way of saying that the market tends to drop faster than it rises, largely because unreasoning fear kicks in during sell-offs.
Sure, we’re enjoying a powerful rally. But the same conditions fueling the surge could act as accelerants during the next market sell-off.
Much of the post-election upward impetus has come from an influx of new and inexperienced individual investors. Since the November 3 election, stocks have experienced record inflows. Margin debt has been soaring as well.
Many of these investors are newbies engaged in day trading to stave off the boredom of quarantine. They’ve been making highly leveraged bets on “story stocks” and dubious initial public offerings. If these stocks stumble, the neophytes could stampede for the exits.
Consider the pandemic-induced stock market crash in late March, which was the fastest than at any other time in history. The increasing prevalence of algorithmic trading hastened the dizzying plunge.
Regardless, there’s considerable justification for continued bullishness. But amid current risks, you need to be highly selective. Don’t put your portfolio on automatic pilot.
Higher and higher…
Stocks finished last week near all-time highs, as Wall Street continued to shrug off near-term risks to focus on positive long-term trends. Investors are embracing “risk-on” assets as COVID-19 cases unexpectedly start to drop.
The coming week will prove pivotal for the stock market’s direction, with more than 23% of S&P 500 companies posting operating results. Initial jobless claims came in better than expected last week while the housing market continues to show strength.
The S&P 500 has gained 14% from November 3 to the inauguration last Wednesday, the strongest post-election performance since FDR’s election during the nadir of the Great Depression in 1932 (see table).
Last Thursday, the S&P 500 hit its fourth record high of 2021 and it’s currently up 72% from the lows of March 2020. How much steam does the rally have left?
Wall Street’s optimism over the new Biden administration comes with a heavy dose of uncertainty. The two most important determinants of market performance in the coming weeks will be biological and fiscal: the effectiveness of vaccine roll-outs and the prospects of more stimulus from Washington. President Biden has made those two areas the main focus of his efforts right now.
Last week, Biden released details of his nationwide coronavirus response strategy, with an emphasis on testing and vaccine distribution. Biden also invoked the Defense Act to facilitate vaccine production. This comprehensive plan is a positive for investors, because it’s designed to hasten a return to economic normalcy.
The Biden administration has proposed a huge fiscal injection worth $1.9 trillion, equal to nearly 9% of gross domestic product (GDP), that would extend unemployment benefits until September. Many Republicans in Congress have suddenly gotten religion about “fiscal prudence” and they’re balking at the size of the relief package, but the odds are good that a relief bill of major proportions will eventually get passed.
Meanwhile, global equities last week resumed their upward trend, regaining their losses of the previous week with a 1.1% gain (according to the MSCI EAFE Index). The International Monetary Fund predicts that the global economy will take off in 2021, in a rare display of “synchronized” growth (see chart).
What about fears of tax increases under Biden? Savvy investors know that such moves would occur down the road, after the economy has healed. As the country grapples with multiple crises, higher taxes are another worry for another day.
Stimulus: Rx for the markets…
The initial fiscal stimulus passed last year, the CARES Act, boosted personal incomes $2 trillion higher than pre-crisis levels. Another round of direct payments to households and extensions of unemployment benefits would keep incomes higher, helping to alleviate joblessness and adding fuel to the stock market rally.
U.S. GDP is expected to grow about 6% this year. In addition, the recent decline in the value of the U.S. dollar against major currencies is boosting corporate revenue growth and profit margins. Fourth-quarter earnings season is still young, with only 13% of S&P 500 companies reporting earnings as of January 22, but so far earnings results are beating expectations by 21.5%.
The stock market “winners” in coming months are likely to include industries such as health care, renewable energy, and infrastructure. Cyclical stocks currently make sense, ahead of the economic upswing.
The economic calendar this week is crowded with market-moving data and events. Key reports to watch: S&P Case-Shiller home price index and consumer confidence (Tuesday); durable goods orders and Federal Reserve Chief Jerome Powell’s press conference (Wednesday); initial jobless claims, domestic product growth, and new home sales (Thursday); personal income, consumer spending, and core inflation (Friday).
Can the Biden Era winning streak last? Wall Street’s current exuberance could indicate that consolidation awaits ahead. The markets already have priced in robust improvements in earnings and the economy, which makes stocks vulnerable to future disappointments.
The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 25.3, which is above the five-year average (17.5) and above the 10-year average (15.7). If we witness an unexpected spike in COVID-19 cases, or if fiscal stimulus dies in Congress, the stock market probably would tumble. I believe that the market rally will continue in 2021, but with dips along the way. You should view pullbacks of inherently strong stocks as buying opportunities.
If you’re looking for buying opportunities now that will continue to prove their mettle throughout this uncertain year, read our special report: “5 Red Hot Stocks to Own in 2021.” In this report, our investment team provides the names and ticker symbols of high-quality stocks that are poised to soar under the conditions I’ve just described. Click here for your copy.