The Battle for Democracy
“Democracy isn’t liberal or conservative, not left or right — at least it isn’t supposed to be. Millions of Americans currently believe that democracy isn’t working, or even that it isn’t worth saving. The battle to prove them wrong isn’t over, it’s just begun.” ~ Garry Kasparov
Markets that are likely to outperform in 2021
There is no reliable benchmark for assessing performance of different markets (stocks, bonds, precious metals, commodities, etc.) since central banks have flooded financial markets with more than $8 trillion in freshly printed currency since the start of 2020. The chart below from Ed Yardeni shows total assets of the five major central banks (Fed, ECB, BOC, BOE and BOJ) expanded to $27.9T at the end of November 2020, from below $20T at the start of the year.
With no convenient benchmark, the best way to measure performance is using relative strength between two prices/indices.
Measured in Gold (rather than Dollars) the S&P 500 iShares ETF (IVV) has underperformed since mid-2019. Respect of the red descending trendline would confirm further weakness ahead (or outperformance for Gold).
But if we take a broad basket of commodities, stocks are still outperforming. Reversal of the current up-trend would signal that he global economy is recovering, with rising demand for commodities as manufacturing output increases. Breach of the latest, sharply rising trendline would warn of a correction to the long-term rising trendline and, most likely, even further.
Commodities
There are pockets of rising prices in commodities but the broader indices remain weak.
Copper shows signs of a recovery. Breakout above -0.5 would signal outperformance relative to Gold.
Brent crude shows a similar rally. Breakout above the declining red trendline would suggest outperformance ahead.
But the broad basket of commodities measured by the DJ-UBS Commodity Index is still in a down-trend.
Precious Metals
Silver broke out of its downward trend channel relative to Gold. Completion of the recent pullback (at zero) confirms the breakout and signals future outperformance.
Stock Markets
Comparing major stock indices, the S&P 500 has outperformed the DJ Stoxx Euro 600 since 2010. Lately the up-trend has accelerated and breach of the latest rising trendline would warn of reversion to at least the long-term trendline. More likely even further.
The S&P 500 shows a similar accelerating up-trend relative to the ASX 200. Breach of the latest trendline would similarly signal reversion to the LT trendline and most likely further.
Reversion is already under way with India’s Nifty 50 (NSX), now outperforming the S&P 500.
S&P 500 performance relative to the Shanghai Composite plateaued at around +0.4. Breakout would signal further gains but respect of resistance is as likely.
Growth/Value
Looking within the Russell 1000 large caps index, Growth stocks (IWF) have clearly outperformed Value (IWD) since 2006. Breach of the latest, incredibly steep trendline, however, warns of reversion to the mean. We are likely to see Value outperform Growth in 2021.
Bonds
The S&P 500 has made strong gains against Treasury bonds since March (iShares 20+ Year Treasury Bond ETF [TLT]) but is expected to run into resistance between 1.3 and 1.4. Rising inflation fears, however, may lower bond prices, spurring further outperformance by stocks.
Currencies
The US Dollar is weakening against a basket of major currencies. Euro breakout above resistance at $1.25 would signal a long-term up-trend.
China’s Yuan has already broken resistance at 14.6 US cents, signaling a long-term up-trend.
India’s Rupee remains sluggish.
But the Australian Dollar is surging. The recent correction that respected support at 70 US cents suggests an advance to at least 80 cents.
Gold, surprisingly, retraced over the last few months despite the weakening US Dollar. But respect of support at $1800/ounce would signal another primary advance.
Conclusion
Silver is expected to outperform Gold.
Gold is expected to outperform stocks.
Value stocks are expected to outperform Growth.
India’s Nifty 50 is expected to outperform other major indices. This is likely to be followed by the Stoxx Euro 600 and ASX 200 but only if they break their latest, sharply rising trendlines. That leaves the S&P 500 and Shanghai Composite filling the minor placings.
Copper and Crude show signs of a recovery but the broad basket of currencies is expected to underperform stocks and precious metals.
The Greenback is expected to weaken against most major currencies, while rising inflation is likely to leave bond investors holding the wooden spoon.
Jim Bianco forecasts higher inflation in 2021
Jim Bianco from Bianco Research:
“The problem the stock market has in 2021 is by most standard metrics (P/E, Market Cap/GDP, etc.) it’s overvalued. Now a lot of people expect it to stay that way for another year. If we don’t get inflation, that can actually happen and you could actually have the market stay at these elevated levels. But if you do get rising interest rates on inflation……that will frip earnings, make mortgage rates go up and lift interest rates. That has historically not been good for risk assets….”
The problem if we don’t get inflation will be far worse. MMT theorists will take this as validation and we are likely to see more calls for far higher stimulus checks. Why not $200,000 stimulus checks someone on Twitter asked. The bubble will keep expanding without any visible effect …..until it bursts.
Stock prices: Jay Powell is talking through his hat
Daily COVID-19 cases in the US continue to climb, reaching 236,211 on Thursday 17th.
Unemployment claims jumped by 1.6 million in the week ending November 28, exceeding more than 1 in 8 of the total workforce (Feb 2020).
Initial claims under state programs climbed to 935,138 (unadjusted) by week ending December 12, compared to 718,522 for w/e November 28, while initial claims under pandemic assistance programs run by the federal government jumped to 455,037 compared to 288,234 for w/e November 28.
Further escalation of both daily COVID-19 cases and unemployment claims is likely before vaccine distribution achieves a wide enough reach to make a difference. A major obstacle will be public reluctance to get the vaccine shot:
As states frantically prepare to begin months of vaccinations that could end the pandemic, a new poll finds only about half of Americans are ready to roll up their sleeves when their turn comes.
The survey from The Associated Press-NORC Center for Public Affairs Research shows about a quarter of U.S. adults aren’t sure if they want to get vaccinated against the coronavirus. Roughly another quarter say they won’t. (Associated Press, December 10, 2020)
Federal assistance
Further federal assistance may soften the impact of rising unemployment on the economy but Senate leaders are yet to conclude a deal. Both sides claim to want a deal but it seems unlikely that agreement will be reached before the Georgia run-off elections on January 5th. If the Democrats win both seats, and a Senate majority, they will not need to compromise. Unfortunately, large numbers of the least fortunate will suffer before then. Real leadership from the White House, needed to break the logjam, is sadly absent.
Jay Powell and stock prices
Jay Powell says he is relaxed about stock prices:
Stocks at record highs and bond yields not far from their historic lows are telling two different stories, but Federal Reserve Chairman Jerome Powell said he isn’t worried about the disparity.
In fact, the central bank chief said during a news conference Wednesday, the low rates are helping justify an equity surge that has gone on largely unabated since the March pandemic crisis lows.
“The broad financial stability picture is kind of mixed I would say,” Powell said in response to a CNBC question at the post-meeting media Q&A. “Asset prices are a little high in that metric in my view, but overall you have a mixed picture. You don’t have a lot of red flags on that.” (CNBC, December 16, 2020)
There is just one problem: bond yields are distorted by the Fed and do not reflect market forces.
S&P 500 PEmax
If we take the S&P 500 Price-Earnings ratio based on the highest trailing earnings (PEmax), this eliminates distortions from sharp falls in earnings during a recession. The current multiple of 26.69 is the second highest peak in the past 120 years, exceeded only by the Dotcom bubble. By comparison, peaks for the 1929 stock market crash (Black Friday) and 1987 (Black Monday) both had earnings multiples below 20.
Payback model
If we use our payback model, we arrive at a fair value estimate of 2169.50 for the S&P 500 based on:
- projected earnings for the next four quarters as provided by S&P;
- a long-term growth rate of 5%, equal to nominal GDP growth in recent years; and
- a payback period of 12 years, normally used for the most stable companies (with a strong defensive market position).
The LT growth rate required to match the current index value (3709.41) is 14.0%. The only time such a growth rate was achieved, post WWII, is in the 1980s, when inflation was spiraling out of control.
Conclusion
Stock prices are in a bubble of epic proportions. Risk is elevated and we are likely to witness a major collapse in prices in 2021 unless inflation spikes upwards as in the 1970s to early 1980s.
To infinity and beyond Part II
Watch from 5:00
Luke Gromen: “Their game plan is to keep treasury yields below the GDP growth rate. The last time they did this was 1945 to 1980.”
A stock market bubble of epic proportions
A great deal has been written in recent years about real estate bubbles, stock market bubbles and even bond market bubbles. But there is really only one kind of bubble — that is a debt bubble. Without low interest rates fueling rapid debt growth, any form of bubble would wither on the vine.
The Wilshire 5000 broad market index, compared to profits before tax, recently peaked above 15.0 for only the second time in history before retreating to 13.97 in Q3. The fall in Q3 is attributable to recovering profits rather than falling stock prices, so a return to above 15.0 seems likely if the index rises in response.
The reason for the surge in stock prices is clear on the chart below: interest rates at close to zero for an extended period act like rocket fuel.
Anna Schwartz, co-author of A Monetary History of the United States (with Milton Friedman, 1963) once said:
If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates.
That is particularly true of the current bubble.
When will it end?
The Fed seems unlikely to change course and is expected to keep interest rates near zero for an extended period, so when is the bubble likely to end?
If bank credit growth stalls, falling to zero (the red line) as it did before the last three recessions, stock prices are likely to tumble.
There may be three possible causes of slowing credit growth:
- Inflation surges, forcing the Fed to raise interest rates;
- Low interest rates cause investment misallocation, as in the Dotcom and subprime bubbles, leading to rising defaults and tighter bank credit; or
- An external shock causes falling aggregate demand and high unemployment, with banks tightening credit policies in anticipation of rising defaults.
Chairman Jay Powell has assured us that the Fed will tolerate higher inflation, with its new policy of inflation averaging, so higher interest rates do not seem to be a major risk. While there has been some investment misallocation, falling aggregate demand and high unemployment seem to be the greatest threat.
Initial claims for unemployment insurance jumped to 853,000 for the week ended December 5th, while initial claims for pandemic unemployment assistance surged to 427,600.
Latest Department of Labor figures (November 21) show total unemployment claims remain high at 19 million — or 1 in 8 people who had a job in February 2020.
Bank credit standards have tightened significantly.
Conclusion
Keep a close watch on bank credit growth. If this falls to zero, then stock prices are likely to tumble.
Commercial paper often acts as the canary in the coal mine, giving advance warning of a credit contraction.
US healthcare killing the host
This chart sums up the size of the challenge facing President-elect Joe Biden.
Mancur Olson (The Rise and Decline of Nations) identified special interest groups as one of the primary obstacles to efficient functioning of the economy, whether they be oil producers, banks, trade unions, or the medical profession. And the more powerful they grow, the greater the obstacle they become.
S&P 500: Leaders no longer leading
Daily new cases of COVID-19 continue to spike upwards, warning of further shutdowns as medical facilities are overrun.
Payrolls
The latest labor report disappointed, especially as the November survey came before the latest round of layoffs after states imposed tighter restrictions.
Payroll growth flattened, leaving total payroll down 5.99% compared to November last year.
Hours worked are slightly more encouraging, down 4.68% on an annual basis, compared to -2.9% change in real GDP.
Vaccines
Encouraging news on the vaccine front but “when you hear the cavalry is coming to your rescue, you don’t stop shooting. You redouble your efforts.” (Dr Anthony Fauci)
Stocks
Progress in manufacturing vaccines that will soon be widely available has buoyed stocks despite the dismal economic outlook. The S&P 500 made new highs, assisted by hopes of further stimulus and ultra-low interest rates. The large megaphone pattern is a poor indicator of future direction but does flag unusual volatility.
Growth in the big five technology stocks has slowed in recent months, with only Alphabet (GOOGL) breaking above its September high. Too early to tell, but failure of market leaders to make new highs is typical of the late stages of a bull market.
Conclusion
Vaccines should succeed in flattening the third wave and suppressing future outbreaks but are unlikely to succeed in restoring the economy to normalcy.
Federal debt is at a record 123% of GDP and growing. Further stimulus is required to support the still-fragile recovery.
The Fed will continue to expand its balance sheet to support Treasury issuance.
Ultra-low interest rates are likely to stay for a number of years.
If massive federal debt, QE and ultra-low interest rates does not cause a spike in inflation, that will encourage authorities to push the envelope even further (we fear this would have disastrous consequences).
Unemployment is expected to remain high and GDP growth likely to remain low.
Zombie corporations and commercial real estate with unsustainable debt levels will continue to be a drag on economic growth.
Growth stocks are expected to remain overpriced relative to current and future earnings.
George Orwell and the appeal of Fascism
George Orwell reviewed Hitler’s Mein Kampf in March 1940. His last paragraph is particularly revealing:
“Also he [Hitler] has grasped the falsity of the hedonistic attitude to life. Nearly all western thought since the last war, certainly all ‘progressive’ thought, has assumed tacitly that human beings desire nothing beyond ease, security and avoidance of pain. In such a view of life there is no room, for instance, for patriotism and the military virtues. The Socialist who finds his children playing with soldiers is usually upset, but he is never able to think of a substitute for the tin soldiers; tin pacifists somehow won’t do. Hitler, because in his own joyless mind he feels it with exceptional strength, knows that human beings don’t only want comfort, safety, short working-hours, hygiene, birth-control and, in general, common sense; they also, at least intermittently, want struggle and self-sacrifice, not to mention drums, flags and loyalty-parades. However they may be as economic theories, Fascism and Nazism are psychologically far sounder than any hedonistic conception of life. The same is probably true of Stalin’s militarised version of Socialism. All three of the great dictators have enhanced their power by imposing intolerable burdens on their peoples. Whereas Socialism, and even capitalism in a more grudging way, have said to people ‘I offer you a good time,’ Hitler has said to them ‘I offer you struggle, danger and death,’ and as a result a whole nation flings itself at his feet…..”
David Wood suggests that society may have eliminated many of the challenges that they faced 80 years ago but this makes us even more vulnerable today. If people don’t have real struggles to overcome, or enemies to fight, they will invent them…..
