With the number of vaccinated Americans rising by the day and the warmth of spring upon us, the distinct air of optimism is taking hold in society and the markets. We are on the cusp of a great reopening where events like dinner out with friends and travels to exciting places are not out of bounds. This summer promises to be almost normal as the pandemic fades. Community basketball courts and swimming pools will likely fill with fun-seeking patrons.
During the first few days of April, it seems almost everyone jumped into the market as well. During the first quarter of the year stocks, as measured by the S&P 500, gained 6%. Early in the story, newly minted millennial investors were spending their stimulus checks in “short squeeze” plays like GameStop and AMC Theaters. Then the shift toward “value” stocks, which had lagged the broader market, attracted increasing numbers of institutions and retail investors. Now, on the heels of robust March employment data and surging readings on the service economy, the moribund growth stocks join the party as the S&P set a new all-time high. These are good days for investors.
The S&P closed at 4,077 on April 5th. If one accepts the consensus rosy view of earnings, the S&P is trading at 23 times 2021 earnings and around 20 times 2022 earnings. Certainly, this is a rich market from a historical perspective, less so when you consider today’s very low prevailing interest rates. In this admittedly pricey market, we believe near term prices can continue higher as ample liquidity on the sidelines finds a home in the shares of a broad swath of companies. Earnings estimates are likely to rise as the full impact of the economic reopening becomes clearer.
With almost every possible investor wading into the market, our thoughts turn to what may come next. In the next year or two the effects of a powerful stimulus may fade. Certainly, we must believe monetary policy will normalize as even this dovish Fed will need to begin tapering its extraordinary support for the economy.
Such a time will feature higher interest rates and, quite likely, higher tax rates as the administration and Congress contemplate paying for their pandemic response alongside a possible infrastructure package. A market coming to terms with these changing conditions may trade at price multiples closer to historical levels as support comes off the boil. When will these more astringent conditions begin to affect stocks? Of course, we cannot predict the exact moment, but will be attuned to changes which may cause investors to become more skeptical concerning the market.
As for now, we believe investors should continue to be fully or almost fully exposed to stock up to their planned allocations. With rates more likely to rise than fall in the coming years, a reduced allocation to bonds also appears sensible.
We appreciate your continued confidence in our team and look forward to meeting in person again soon!
The Altavista Investment Team – Spring 2021