Legendary portfolio manager Jeremy Grantham of GMO has seen every kind of market. In this report calls the current bubble one of the “four most significant and gripping investment events of my life.” He explains why resisting the allure of such bubbles is hard, but typically pays off in the long run. Bullish investors especially should consider his thoughts carefully.
Key Points:
- The rapid price rises seen at the end of a bull market bring anxiety and envy as people see their neighbors getting rich.
- Crazy investor behavior is the single most dependable feature of late-stage bubbles. We see plenty of it now.
- The current gap between high market valuations and low economic expectations is completely without precedent.
- Grantham’s best guess is the bubble will last until the COVID vaccine removes the most pressing issue and investors realize the economy is still in poor shape.
- Great bull markets typically turn down when market conditions are still favorable, but subtly lessfavorable than they had been.
In assessing what to do, Grantham suggests avoiding US growth stocks to the extent your career and business risk will allow, and looking instead to value stocks and emerging markets.
Here’s the deal, though… The Fed can’t save the day forever.
Interest Rates
Hoisington Quarterly Review, Q4 2020
Van Hoisington and Lacy Hunt have spent years arguing, correctly, that long-term Treasury yields will keep moving lower. Every quarterly report again explains why. The argument is elegant because it’s core is just math. Or in another sense, it’s plumbing. You can count on water to always flow downhill.
Key Points:
- Many market forecasters believe interest rates will rise this year as additional fiscal and monetary stimulus creates inflation.
- One problem with this: GDP measures new output and misses the wealth destruction caused by the pandemic and the policy responses to it.
- Further, the kind of fiscal stimulus we are getting is non-investment spending with a negative fiscal multiplier.
- The fiscal multiplier is negative because the spending is primarily debt-financed, causing a further drag on economic activity.
- Low debt productivity suppresses the velocity of money, making sustained inflation difficult if not impossible.
- Since the US Treasury effectively has no credit risk, inflation is the main determinant of long-term Treasury rates. The Treasury bull market will therefore continue until we see a secular inflation cycle, which is not presently at hand.
Diary of Market Peaks
January 23, 2020: Stocks have one of the best 3-month returns ever, dating back to 1928
February 5, 2020: Cash hits the 2nd lowest level in 40 years, signaling major complacency
February 13, 2020: S&P 500 hits 36 all-time highs in 4 months; 5th most since 1928
February 19, 2020: Confidence in stocks has never been higher
February 24, 2020: Dow Jones Industrial Average dives 1,000 points on pandemic fears
February 25, 2020: Most lopsided selling pressure in 60 years
March 5, 2020: Risk appetite the lowest it can go
March 9, 2020: Worst day for the energy sector since 1926
March 12, 2020: Pure, unbridled panic
We all know what happened next…
In addition to the Fed’s rescue efforts, central banks around the world slashed interest rates and unleashed colossal stimulus programs to support financial markets. And then, on cue, the stock market roared back to life… It has been on fire ever since, even hitting new highs.
Recent diary entries…
December 11, 2020: The most companies since 2000 have gone public without first being profitable
December 14, 2020: 15-year high in percentage of indicators exhibiting extreme optimism
December 16, 2020: Only 32 days have been part of back-to-back losing sessions, the fewest since 1928
December 21, 2020: A multiweek or multi month decline from here wouldn’t be all that unusual
22, 2020: Never been more “severely overvalued” companies in the S&P 500 (i.e., P/E ratios > 30x) over the past 40 years
January 13, 2021: Massive spike in speculative activity
In short, with the stock market sporting rarely seen valuations and sentiment again hitting optimistic extremes, it’s time to prepare for the next big swing in investor psychology.
At some point, the pendulum will rocket back toward extreme fear.
A Tale of Two Americas
Consumers – in aggregate – are in the best shape they’ve ever been in. Right?
But the distribution of that prosperity has never been more extreme.
Take two recent CNBC headlines:
Headline 1 – U.S. savings rate hits record 33% as coronavirus causes Americans to stockpile cash
Headline 2 – 61% of Americans will run out of emergency savings by the end of the year
Or these two:
Headline 1 – Household wealth surged to a record high during the pandemic
Headline 2 – More Americans are shoplifting food as aid runs out during the pandemic
That’s the story.
There are 9 million fewer jobs today than a year ago, a decline of around 6%. But for those earning more than $28 per hour, the job market has fully recovered, like the recession never happened. For those earning less than $16 per hour, one-quarter of the jobs are still gone, which is on par with the 1930s.
Jobs Recovery
The colored lines represent job losses in all recessions since 1948, scaled by months after peak employment. You can see how 2007 brought a deep decline and slow, 6+-year recovery. You also see how 2020 brought an even deeper plunge, followed by a quick but incomplete recovery.
The ominous part is how the most recent jobs recovery sagged so quickly. As of December, it was pointing down again. We can attribute this to the winter COVID-19 surge and associated business closures, but knowing the reason doesn’t mean we have a solution. With the vaccine campaign off to a slow start and virus cases climbing, the jobs recovery may have peaked for now.
The headline unemployment rate is convenient to watch but doesn’t convey the full picture even in a “normal” recession. The COVID downturn is even more complex. This graph tries to fill in the gaps.
The official data tells us 10.7 million are unemployed, but they aren’t the only ones feeling negative effects. Another 7.5 million who were working in December had their expected pay or hours reduced in the last four weeks because the pandemic affected their employers. Another 4.9 million (EPI’s estimate) left the labor force since last February, often because they needed to care for young children or elderly relatives. Another 3.7 million are unemployed but, for wonky statistical reasons, likely misclassified as having dropped out of the labor force. Add all that up and something like 26.8 million workers are feeling some kind of pain from the pandemic. This is a deep hole and will take a long time to fill.
The Labor Department reports both the national unemployment rate and, with a month’s delay, unemployment by metro area as well. The red dots in the map below tell you where unemployment is the highest.
As of November, 12 metro areas had 10% or higher unemployment. Some are tourism-dependent areas like Las Vegas, Maui, and Atlantic City. Pandemic-related reluctance to travel and event cancellations hit them hard. Several others are agricultural areas along the Mexican border. These, too, are at least partly due to pandemic changes in the way we eat. The map shows something else interesting, too. Note the light-colored circles in the upper Midwest and Great Plains. These areas show low unemployment. Even with the nation suffering in aggregate, there is always good news somewhere.
A Major Contraction in Jobs
Thursday morning’s worse-than-expected weekly jobless claims brought to mind George Friedman’s note from a few days ago. He says the weakening jobs picture points to deeper economic problems. The challenge isn’t just the virus, but the uncertainty it creates for business planning.
Key Points:
- Friedman said last spring we had until late fall to deal with the pandemic without risking depression. We are now in the danger zone.
- The jobs lost in December were the result of decisions businesses made about what they expect in 2021.
- Cutting staff just before the new year is an indicator that those who know the economy best are worried.
- The inability to predict when normal life will return creates uncertainty that requires defensive action.
- It isn’t the virus as much as the fact there is no way to grasp how long it will take to get past this.
Contrary to stereotypes, most businesses don’t cut jobs lightly. Finding reliable workers is difficult and expensive. If the job losses continue it will mean business sees a very different economy than the investors who are driving stock prices higher.
COVID News
Which countries have been hit the hardest by the pandemic (in terms of the number of deaths)?
COVID Virus and the US Economy
The one thing we can say with certainty about this year is that the virus outweighs everything else. The economy can grow if we control the virus, or more likely shrink if the virus keeps spreading.
Growth prospects depend heavily on vaccine success. The World Bank’s annual forecast was very plain about this. It has four scenarios:
- Upside Scenario:Vaccine campaigns proceed swiftly with wide public cooperation, allowing governments to roll back their precautionary measures. Economic uncertainty dissipates and 2021 sees 5% global GDP growth, but a return to prior trend in 2022 with only 1.7% global growth.
- Baseline Scenario:Caseloads fall in major economies as inoculations proceed, with social distancing measures gradually reduced. Economic activity recovers as household consumption returns. In that case, the World Bank expects 4.0% global growth in 2021 and 3.8% in 2022.
- Downside Scenario:Cases remain high as supply bottlenecks and logistical problems slow vaccine deployment. Activity remains depressed as households continue to fear contact-intensive services. Here, it expects global growth of only 1.6% in 2021 and 2.5% in 2022.
- Severe Downside Scenario:As in the downside scenario, the pandemic is difficult to manage and vaccine distribution is slow. The prolonged economic slowdown erodes corporate balance sheets and triggers widespread defaults and concerns for bank balance sheets. It gets worse from there, too. This would give the world economy another year of recession, with global growth somewhere below zero (they are oddly non-specific on this point) in 2021 and bouncing to just 2% in 2022.
China’s economy is bouncing back while the virus has mostly spared Africa, at least so far, though the situation in South Africa is deteriorating quickly.
The part I circled is its 2021 forecast for advanced economies if vaccines go well (blue bar) or not so well (red bar). The difference is dramatic. Note carefully, these are the two middle scenarios. I think their optimistic scenario, given the latest data, is now sadly unrealistic. We have a nontrivial chance of experiencing the worst case.
There is good news, so let’s start there. After a very shaky and mostly slow start, federal and state officials in the US are reorganizing the vaccine rollout. One of the good things about the US federal system is that we can conduct 50 different “laboratory experiments.” In this case, West Virginia and Florida seem to have found better ways. Others are learning from them and the number of people vaccinated should grow quickly in the coming weeks. Plus, since many companies are still working on their vaccine trials, we may have many more vaccines available later this year and next year.
I see better than 60–70% odds that the robust recovery scenarios many see for the latter half of 2021 will prove too optimistic. I desperately hope to be wrong, but restarting 150,000+ small businesses is no trivial matter. Further, all this talk of “pent-up demand,” is unrealistic.
Wall Street Year End Targets for 2021
I read most of the mainstream analyst’s predictions to get a gauge on the “consensus.” This year, more so than most, the outlook for 2021 is universally, and to some degree exuberantly, bullish.
What comes to mind is Bob Farrell’s Rule #9 which states:
“When everyone agrees…something else is bound to happen.”
US Economy
- The US lost 140k payrolls last month
- Most of the losses were in leisure and hospitality.
- Sectors with higher wages continued to recover.
- This chart shows the employment trajectory compared to the 2008 recession.
- How many workers have been impacted by the pandemic?
- When will we see employment return to pre-crisis levels? Here is a forecast from Oxford Economics.
- And this is a forecast from Deutsche Bank.
- One troubling trend in the labor market has been small-business employment.
– Homebase small business employment index:
- Paychex/IHS Markit Small Business Employment Watch:
- The US remains over-retailed compared to other countries.
Department store retail sales have declined since the financial crisis.
The COVID situation remains worrisome.
- Bloomberg’s consumer sentiment index deteriorated further, driven in part by the recent events in DC. Americans are also increasingly uncertain about personal finances (2nd chart).
- Initial jobless claims increased last week. Weekly unemployment claims jump to 965,000 as virus takes toll
- Here is a comment from Oxford Economics. We think the $300 in additional weekly benefits provided by legislation enacted late in December motivated more individuals to claim benefits.
Watching for Inflation
Changes in consumer prices for selected food items:
Office occupancy rates:
The Cycle of Monetary Policy
- Using monetary policy to drag forward future consumption leaves an enormous void that must get continually refilled in the future.
- Monetary policy does not create self-sustaining economic growth and therefore requires ever-larger amounts of monetary policy to maintain the same activity level.
- The filling of the “gap” between fundamentals and reality leads to consumer contraction and, ultimately, a recession as economic activity recedes.
- Job losses rise, the wealth effect diminishes, and real wealth gets destroyed.
- The middle class shrinks further.
- Central banks act to provide more liquidity to offset recessionary drag and restart economic growth by dragging forward future consumption.
- Wash, Rinse, Repeat.
All content is the opinion of Brian J. Decker
