Steve Allen, initial host of the Tonight Show, composed the show’s first theme song, “This Could Be the Start of Something Big!”. It was an infectiously upbeat theme. The nostalgic should check it out on YouTube, particularly when you need to feel optimistic. For some reason, the tune came up when, as an investment team, we were discussing the approval and rollout of the vaccines for the COVID -19 virus. Certainly, the vaccines give us reason to believe the post-virus world lies just ahead and that our pandemic limited lives are about to be emancipated. This awful disease has taken and interfered with so many lives. Absolutely, cue the band if the end is in sight.
If true, then sunset also begins on some of the extraordinary support given to the economy and markets by the Fed and our government. We should applaud the effectiveness of measures taken by the administration and Congress. Enhanced unemployment benefits and loans to small businesses were key to an economy which rebounded furiously after the shock of the lockdowns in March and April.
Remarkably, personal income and savings actually accelerated during the biggest economic downturn since the great financial crisis over a decade earlier. We ended 2020 with sales of goods higher than in 2019. Consumers continued to spend as online sales took share from brick-and-mortar retailers. Businesses invested in capital goods particularly technology which allow their workforces to work remotely. Spending on travel, dining out and other services is still down, but rebounding.
Stock markets properly discounted the strong economic recovery and advanced, assisted greatly by a Federal Reserve, that left no doubt about its intent to keep interest rates low and markets supplied with liquidity. M2, a measure of the supply of money, has increased by over 25% during the crisis. These heroic measures cushioned the economic and market fallout. What does the end game of this chapter look like? How will markets react to a new environment?
For stock markets, we believe today’s optimism will have to be justified. Earnings in 2020 will be 14% lower than in 2019, while stock prices are 15% richer than before the pandemic. Analysts currently predict that earnings in 2021 will just about match those of 2019. While this expensive market gives us pause, we believe stocks will likely trace a halting and volatile path ahead as pent-up demand and more efficient businesses fuel robust 2022 profit projections.
A rise in interest rates would be a problem for stock and bond investors. We have every reason to believe that any increase in rates will be gradual. This should limit any near-term adjustment in stock prices.
There are, however in our view, some factors that bear special attention as 2021 progresses. Unemployment, while improved, is still almost twice the pre-pandemic rate. As stimulus fades this will weigh on personal income as we look forward to 2022. Continued improvement in the labor numbers is key to our positive outlook. Inflation, an old nemesis for investors seems nigh well extinct at this point. However, the rapid increase in the money supply coupled with a potentially free spending Congress means we will have to watch for early signs of an acceleration of this threat.
We are grateful for the privilege of serving our clients and the confidence you have reposed in us. We look forward to connecting with you in the New Year.
The Altavista Investment Team ~ Winter 2021