Coronavirus cases in the United States have been declining since June, and there are nine vaccine candidates in Phase 3 clinical trials. The economy, while still operating below pre-pandemic levels, has staged a robust and rapid recovery. Corporate earnings expectations are now rising. The Federal Reserve has reconfigured the way it will conduct monetary policy and has communicated that they’ll be supportive of growth while shooting for an average inflation rate of 2%.
For these reasons, when it comes to stocks, we think the message of the markets is clear, and we expect more gains over the next few years-- at least, from big tech and the certain companies that control data. Valuations are ridiculous and news flow feels relentless, but market strength is an accurate reflection of the value investors are willing to pay for secular (non-cyclical) growth-- the tech sector has been able to meaningfully grow earnings throughout the pandemic.
It may not seem compelling to invest in U.S. equities now when they are near all-time highs, but the macroeconomic, monetary and business cycle environments all seem supportive for equities over the next three to five years. New home sales are growing at their fastest pace since the early 1990s, indicating that we’re in the midst of a strong early-cycle recovery, and the Fed has signaled it is going to keep interest rates low for a long time. This is supportive both for future earnings expectations and equity valuations. In particular, lower rates support our view that secular growers like those among large tech will command a premium from investors. The reason is one we’ve discussed frequently: TINA (There Is No Alternative). Cash flows that happen far in the future are even more comparably valuable when discount rates are low. So, it may not feel like you’re getting a bargain when you get filled, but we think equities can still provide compelling returns over the next several years.
Inflation is still a long way from getting to a sustained level where the Fed would raise rates to put the brakes on growth, and interest rates are probably not going to move materially higher anytime soon. Therefore, cash should be viewed very critically. We recommend that investors prepare for volatility by maintaining some cash on the sideline for buying dips, but that’s because we expect plenty of dips.
When the S&P 500 has been up five straight months, as it was in April through August, stocks historically have kept going higher. In fact, the last 26 times the index rose for five straight months, it was higher a year later 25 out of 26 times. We also know from history that bull markets tend to run for years, and the one that started March 23, 2020, is very young. On the other hand, the $7.8 billion triple-leveraged ProShares UltraPro QQQ (TQQQ) ETF attracted more than $1.5 billion in the past eight days, the most for such a span since it began trading in 2010. Meanwhile, its non-leveraged peer Invesco QQQ Trust Series 1 (QQQ) saw $4.8 billion in outflows last week — the worst in more than 20 years.
When 20,000 Robinhood accounts pile into a triple-leveraged investment vehicle while pensions dump the underlying index, it becomes clear that this whole thing is a just a glorified casino over the short term-- which from my point of view just means that stocks sometimes go on sale. Volatility is to be embraced, and longer-term economic fundamentals appear to be legitimately improving.
As far as concerns among investors about risks to those fundamental underpinnings, political risk is the one that we hear about from clients every day, and we think those concerns are overblown. We are a nation of 328 million immigrants with four large racial demographics and 45 spoken languages (and with 41 million Spanish-speakers) that is spread out over 3.7 million square miles and across 50 states. That voters can’t agree on anything should no longer be a shock to anybody. This economy is still terrible, but it has gotten a lot better, and especially in the ways that financial markets care about.
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