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Investment Review/Outlook

Current Investment Outlook

Markets continued to move forward in the first quarter, based on the expected recovery in earnings and continued low interest rates. A protracted tug of war, however, has been established between the flood of liquidity which seems destined to flow into equities and the inflationary forces of unprecedented fiscal and monetary stimulus. In this sort of developing circumstance, owners of assets benefit, while holders of debt securities and cash lose ground.

Since the Financial Crisis in 2007-08, there have been many surprises along the way. And, yet, we have been optimistic about the direction of the market throughout this entire period. The reasons for having this view are the dynamic and enduring power of the U.S. economy and the fact that the Federal Reserve and other Central Banks have kept interest rates as low as they realistically could almost all of this time. While it is possible to speed up or slow our economic growth, it is almost impossible to turn off the creative ingenuity of the American entrepreneur. As for interest rates, they will stay low for a long time, but not forever.

Investment markets can perplex even veteran observers with their ability to look months and quarters ahead and discount future events. In that spirit, while there are many developments yet to come, it is time for the markets to declare victory over the Coronavirus Pandemic. With the extraordinarily successful Warp Speed program, over 50% of the U.S. population has already received one vaccine, and over 30% have had two. Add in those who have been infected, and we are at or near a point of herd immunity. This is not to trivialize this virus, because people are still getting infected and dying, but in a practical and predictive sense, the battle is over. The caution today, and we would be remiss not to worry about this, is that there will continue to be mutations of the virus and that we may see new viruses unleashed upon the world, because evil people have seen how powerful such a pandemic can be.

A year ago, we were comparing the toilet paper shortage to the gas-line panic in the mid-1970's. Back then, people would fill their gas tanks, and then top them off whenever they saw a gas station open with a line of cars. People were hoarding gasoline. We explained that the same thing was happening with toilet paper and that the panic would pass with time. Now, a year later, Kimberly Clark has confirmed what we were saying then. Their 2021 first quarter was disappointing because it compared with the wild demand from a year ago when consumers were figuratively filling their attics with toilet paper. Human nature rarely changes.

The U.S. economy is projected to report a burst of recovery in 2021, with GDP growth between 6% and 8%. The housing market is growing strongly, with an 11% increase in prices. Even so, there is a shortage of housing in comparison with demand. Unemployment is down to a 6.8% rate versus a 14.8% peak last year. Corporate taxes will slow the recovery if they are raised from 21% to a 25-28% level. Earnings for the S&P 500 are expected to grow to $180 and possibly as high as $200.

Our friend Ed Yardeni has posted an interesting chart which compares the year-over-year growth in the S&P 500 with the PMI manufacturing index. While this index rises with our recovering economy, he argues that the path of least resistance is still much higher for stocks. He is probably right.

Fiscal policy is flat-out stimulative, following last year's generous COVID spending, with an additional $1.9 trillion stimulus, a probable $2 trillion infrastructure bill, and a possible $2 trillion plus bill to follow. Not to be outdone, the Federal Reserve has been buying assets with abandon. The monetary situation is unprecedented, with money supply growing at a 30% rate. There is $4.5 trillion of cash on the sidelines, in a practical sense with nowhere to go but into equities. The U.S. ten-year rate ran quickly from 0.92% to 1.75%, before dropping back somewhat, but short term rates linger just above zero. Long rates do not yield enough to attract investors when the risk is high of somewhat or much higher rates in the years to come. Worldwide, there is still $18 trillion at negative rates. These bond rates are punitive. Investors can invest short at zero or negative rates, or buy equities.

Many of you may have wondered what is all of the fuss about Bitcoin. There are both speculative and potentially sound reasons for the crypto currency excitement. When nations around the world are printing money at a frenetic pace, it is reasonable to seek a medium of exchange which is fixed in issuance and can grow in value while currencies deflate. This has traditionally been the role of gold and silver – and it may still be today. But, the crypto currencies offer an alternative hedge against the inflation caused by printing money. In addition, bitcoin and others may be validated by organizations which will allow its use in transactions. This is still quite new, but it is the sort of thing that happens when currencies devalue themselves.

China dominates the international picture. With COVID, they may have won the battle but lost the war. Companies have moved to source in Vietnam or India or elsewhere, so that they are no longer at the whim of an unreliable supplier. At the same time, China and other countries (Russia, Iran, North Korea) are testing the military resolve of our new President. The early signs are concerning.

The stock market bounced quickly off its March, 2020 lows, with the expectation that medical solutions to the Coronavirus would be forthcoming. The 33% decline gave way to a 79% recovery. The early leaders were the stay-at-home companies, but that began to shift in favor of the re-opening stocks. Growth led for months, and then value began to recover. Investor sentiment is high today, but liquidity in the market is even higher. We think the market trend remains upward, but the amount of borrowing worldwide (and in the U.S.) is most concerning. The valuation today is 21.8 times a $180 forecast for the S&P 500 or a much more reasonable 19.6 times a $200 number. With its revolving leadership as the market broadens, energy, financials, and industrials have led in early 2021. Stock selection remains key, especially as so many investors, individual and institutional, have chosen to invest in one index or another. Not all stocks in a stock index have the same future prospects, and we will continue to look for the ones which have the best dynamics and fair valuations.

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