Global Trend

The world is awash in liquidity, real interest rates are negative, the global economy is just beginning to come roaring back after the self-imposed shut-down, a whole new generation of technology is beginning to drive a new wave of productivity gains, fiscal policy is super-charging business & consumer demand, taxes are likely to stay low and business leaders are unusually optimistic about future earnings. Yet market turmoil is reversing gains in the stocks of some of the most innovative companies. Why is this happening? What lies ahead for stocks in 2021? And what risks and opportunities will this create for investors?  We’ll show you.

The Trends editors primarily focus on scenarios playing out over three or more years. For example, the Fifth Techno-Economic Revolution is expected to last over sixty years, having begun in 1972 and continuing into the mid-2030s. Just the current “Golden Age” is likely to run for up to 15 years, followed by up to 7 years of “Maturity.”

Those who don’t recognize that secular trend are now erroneously expecting sub-par equity returns over the coming decade. On the other hand, the Trends editors foresee an era of strong performance, particularly for the stocks of companies embracing the transformative power of AI, 5G, Genomics, and the Internet of Things. As always, the dominant drivers of the economy are technology, demography, and long-term behavioral trends.

Shorter-term, it is cyclical trends which dominate. Cyclical trends are more obvious than secular trends and they are much more likely to be influenced by the decisions of policymakers. And inevitably, it’s these short-term trends that drive virtually all of the content in the Wall Street Journal, on business cable shows, and in-market newsletters. Even the “Economic Insights” column in our sister publication Business Briefings features guidance for those making short-and-medium-term decisions.

The challenge is to avoid fooling oneself by trying to explain every up or down that occurs in terms of these causal agents. The futility of that exercise was first quantified in a research paper titled “Large Financial Crashes,” published in 1997 in the European scientific journal, Physica A. In part, the researchers said, “Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in the natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their actions) all information contained in market prices, we propose that the market as a whole can exhibit an “emergent” behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology, for instance in animal populations such as ant colonies or in connection with the emergence of consciousness.”

Much like dealing with classical mechanics vs quantum mechanics, stock markets should be thought of as deterministic and predictable at the long-term macro level, but probabilistic at the short-term micro level. That explains why market timers almost always underperform the indexes; they are trying to predict the unpredictable. Meanwhile, Warren Buffett epitomizes the successful “buy and hold” investor who does the work necessary to make the most of predictable long-term performance trends.

In the short-term, it’s hard to say what’s going to happen next week or even next month. However, we can confidently say that the secular bull market that began in 2013 remains firmly intact. Furthermore, we can confirm that the cyclical bull market that began in March 2020 is still following a very rational multi-year trajectory, given today’s rebounding macroeconomic context.

Based on that understanding, the Trends editors are prepared to explain why we believe 2021 will be a great year for stocks despite recent anxiety.

Consider the facts.

The Democrats just enacted a $1.9 trillion stimulus bill into law. This huge fiscal boost is far larger than was needed to get us to the other side of the COVID19 reopening process. As of mid-March 2021, the world was already in a global economic recovery. U.S. planners finally had their arms around the coronavirus pandemic. Reopening continued to accelerate. And business activity was picking up quickly, even in the industries most hurt by the shutdowns, such as airlines and hospitality.

For at least the remainder of this year, financial markets will continue to climb the proverbial “wall of worry” as investors watch a tug-of-war among competing forces. These forces include:

- an accommodative Fed willing to accept higher inflation until unemployment declines to pre-pandemic levels;

- a steepening yield curve; and

- businesses reporting much higher earnings, cash flows, and returns on invested capital.

While the equity markets could certainly correct briefly sometime this year, any such correction will simply be an opportunity to buy stocks of companies poised to benefit from the growth surge. Why? The biggest short-term reason for rising stock prices is the unprecedented worldwide glut of excess liquidity already looking for a home, and trillions more are on the way. In fact, it appears that we are only in the early innings of a supercharged economic recovery that will last for several more years. That means it’s time to be an investor, not a trader. Buy the stocks that meet all of your criteria and only sell them if they begin to fall short on key metrics.

For over a year, we’ve known that the speed and sustainability of the global economic recovery depended on getting our arms around the coronavirus, which, as we all know, was the cause of the severe recession in the second quarter of 2020. 

Fortunately, news on that front is getting better by the week as the number of cases and deaths continues to fall sharply and the number of people getting vaccinated increases substantially week-by-week. As of mid-March, nearly 2 million doses per day were being distributed in the United States; and as vaccine availability improves, this will accelerate.

 

After signing the new $1.9 trillion stimulus bill President Biden said he expects all adults to be eligible for COVID vaccines by May 1st. And he anticipates that we will be able to gather in small groups anywhere in the country by the Fourth of July. This seems like a pretty low hurdle since it is clear that Pfizer, Moderna, and J&J will have more than enough vaccines available for all Americans by the summer and for everyone in the entire world well before year-end. And billions more vaccines and boosters will be available in 2022 if needed.

Despite the fact that the reopening has a ways to go, the U.S. and the global economy have already rebounded from the virus, months ahead of where most analysts expected it to be at the middle of March. In fact, the recent statistics are nothing short of phenomenal when you consider that we have just begun accelerated business and school openings. For example, final demand for goods rose 1.4% in February, exactly the same as the jump we saw in January; the index for final demand services rose 0.1% in February after increasing 1.3% in January; U.S job openings (known as JOLTs) increased to 6.92 million, a one-year high; jobless claims fell to 712,000, a multi-month low; and the consumer sentiment index rose to 83, a 12-month high.

In February and March fear, uncertainty and doubt was irrationally revved up due to the specter of 1970s-style inflation depressing earning and multiples. However, the facts imply that this fear is unwarranted. The U.S. inflation data for February 2021 showed an increase of 0.4% overall, resulting in an annualized consumer price index (or CPI) rate of 1.7%. At this point, the main drivers of the CPI remain energy and food, with the core index rising just 1.3%. For March 2021, the annualized rate will increase due to the lockdown-related slump in energy prices in March through June 2020, but these oneoff impacts on the index will subside later in the year. Meanwhile, the five-year inflation expectations as of February were running at 2.1% as indicated in Exhibit 1 in the printable issue.

Notably, some economists fear that as consumers emerge from the lockdowns, buoyed by government stimulus, the surge in demand for manufactured products may not be immediately satisfied, potentially driving up prices. Expected supply tightness can already be seen in the shortage of shipping capacity as well as in an up-tick in commodities prices. Furthermore, the producer price index for manufacturing in China has started to pick up, surpassing early 2019 levels, as indicated in Exhibit 2 in the printable issue.

Fortunately, these price pressures are likely to be temporary given that most firms can quickly ramp up incremental production capacity. One reason is that the labor force participation rate in the U.S. remains quite low compared to the 1990s and early 2000s, meaning that hourly labor cots are not likely to surge as unemployment falls.

Today, globalization is even more important than “labor force slack” in preventing a surge in labor costs. The U.S. economy is now three times more open than it was during the 1970s. Greater “trade openness” places major downward pressure on nominal wages because goods and services can be offshored if wages become too uncompetitive.

That means that rather than obsessing about inflation, investors need to recognize that the biggest driver of medium-term economic growth and share prices will be the extraordinary level of liquidity in the financial system, with much more on the way. This liquidity surge is one reason U.S. household net worth surged to $130.2 trillion at year-end 2020, boosted by rising stock prices, higher residential real estate values, and record household savings rates.

Further boosting spending power, consumer debt rose in the fourth quarter of 2020 at the fastest rate in 13 years, with an annualized increase of 6.5%; that was mostly due to mortgage refinancing at historically low rates. On the other hand, business debt increased in the fourth quarter of 2020 at an annual rate of only 0.8%, while government debt increased at an annualized rate of 10.9% in that period. Low corporate debt-service costs plus consumers freed from lockdowns and “flush with cash” is a formula for surging corporate earnings ultimately reflected in capital gains.

So, what’s the bottom line?

Trends is forecasting a supercharged economic recovery in 2021 likely extending through 2022.

There is certainly plenty of buying power to fuel this scenario. As stated earlier, Americans had a household net worth of $130.2 trillion. At the end of 2020, then the government passed a one-trillion-dollar stimulus bill at the beginning of 2021, followed by a $1.9 trillion additional stimulus bill in early March, which may be followed this summer by a multi-trillion-dollar bill focused on infrastructure projects. That would be an additional $5+ trillion in stimulus this year on top of last year’s stimulus, which many consumers saved contributing to the record yearend net worth figure.

Not surprisingly, the OECD raised its economic forecasts for 2021, saying that U.S. stimulus will turbocharge world growth even as Europe lags. It increased its world growth forecast to 5.6% from 4.2% and more than doubled its forecast for U.S. growth to 6.5%.

 

The European countries still need to accelerate their vaccination programs; their central banks need to remain extraordinarily accommodative; and their fiscal policies need to be highly stimulative. In line with this recipe, the ECB decided in mid-March to speed up bond purchases, so as to prop up the European economies further. And we also expect the Bank of Japan to will further tweak its policies to boost 2021 growth.

All this good news supports our global growth thesis.

Therefore, the Trends editors conclude that the world now has all the stimulus that’s needed to support and boost global growth. And as excess liquidity drives financial asset values higher, the combined economic tailwinds will continue to reassure equity investors.

Therefore, as we are putting the virus in the rearview mirror, we have entered a period of extraordinary economic growth and prosperity. We can already see that the period immediately ahead will be boosted by stimulative fiscal policies, accommodative monetary policies, and the trillions of dollars worth of excess liquidity already in the financial system. Since this liquidity is far beyond real economic needs, it will inevitably drive up the value of risk assets. The key is to be on board as the train leaves the station sometime in April.

Given this trend, we offer the following forecasts for your consideration.

First, the yield curve will continue to slowly steepen. But it will do so for all the right reasons including accelerating global growth, increasing capacity utilization, rising inflationary expectations, and increasing loan demand. Contrary to what a lot of pundits would have you believe this is good news!

Second, inflation will definitely run above 2% for a while, but it’s not something to be concerned about long-term. Expect inflation to fall back to lower levels after an initial period of adjustment to the post-lockdown demand surge. The Trends editors see consumer prices contained by much higher productivity, global competition, technological advancements, and disruptive innovators popping up everywhere. And, in any case, the Fed is now committed to keeping short-term interest rates near zero until at least 2023, regardless of inflationary signals.

Third, market multiples are peaking, but there is every reason to expect that they will stay elevated for quite some time. We are in a period of rapid economic growth when relevant multiples are defined by future profits, not trailing earnings. The S&P500’s forward P/E of 20.5 is higher than the long-term average, but consistent with norm’s seen during past economic booms. Therefore, there is no reason to worry, as long as you’re investing in economically sensitive companies whose earnings, cash flow, and return on invested capital are likely to surprise on the upside due to accelerating growth, rebuilding of inventories, pricing improvements, and operating margin increases.

Fourth, the S&P500 index will end 2021 at 4500-to-4700 after a strong upturn starting in April. Consider just four statistically significant bullish signals (indicated by a Z-Score of 2.0 or higher) which have occurred during the first quarter of 2021 and what these may portend for the rest of the year.

The first signal has to do with volatility. On February 25, the VIX jumped 40% and the index was above 30 intra-day. Between 1990 and 2021, whenever this has happened, the S&P500 has been up 6 months and 1 year later, 100% of the time. The average 6-month rise was 21.5% and the average 1-year rise was 24.4%.

The second signal has to with market breadth. On January 27, the number of S&P500 stocks which were above their 50-day moving average dropped more than 20%, while more than 75% of S&P500 stocks remained above their 200-day moving average. Between 1928 and 2020, whenever this has happened, the S&P500 has been up 2 months later, 96% of the time. The average rise has been 7.6% 2 months later and 19.4% one year later.

The third signal has to with the ongoing recovery of global stock markets. On January 8, fewer than 20% of stock markets in other countries were in correction for the first time in more than 9 months. Between 1971 and 2020, whenever this has happened, the S&P500 has been up 100% of the time both six months later and 1 year later. The average 6-month rise was 10.7% and the average 1-year rise was 18.2%. And,

The fourth signal involves stock market corrections. The NASDAQ composite has recently experienced a correction of greater than 10% within one month of an all-time high. This is actually a very bullish sign. Between 1971 and 2021, whenever this has happened, the NASDAQ Composite has been up 1 year later, 90% of the time. And the 1-year rise has averaged 43.0%.

With these four signals, history is sending a clear message: Despite all the articles and “talking heads” to the contrary, this is still a bull market, and it likely has much higher levels to reach in the month and years ahead. That means pullbacks are buying opportunities rather than shorting opportunities! And,

Fifth, portfolios focused on the stocks of companies with new business models, extraordinary competitive positioning, and revolutionary technologies will substantially outperform the major market indexes. Consider the PARE-5 strategy in which the Trends editors invest. It has generated a total return of over 27% a year compounded since 1998. Over that period, the S&P500 index returned 8.28% annually and the NASDAQ Composite index returned 9.71% annually. While past performance is no guarantee of future results, this track record suggests that consistent application of a “rules-based strategy” can produce two-to-three times the annualized returns of the major indexes. (If you’d like to find out more about the PARE-5 strategy and whether it might have a role in meeting your financial objectives, call 630-399-1319 or email carolyn.thur@ampf.com )

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