Stocks paused yesterday, a session rather quiet on both the earnings and news front. Bond yields were flat as well.
Over my last three letters, I have tried to make the case that both fiscal and monetary policy, extremely positive at the moment, are likely to continue pushing stocks higher in the short run. But when too much money chases too few goods, you run the risk of unintended consequences. So far, those have evidenced themselves through a rise in speculation across many asset categories, including stocks. No one can define when this all comes to an end, and as long as both the Fed and Congress keep pouring money in, logically the amount of speculation will increase not decrease.
As we have learned recently in the short squeezes centered on the likes of GameStop and AMC Theatres, there is a point where absurdity finally gives way to valuation. GameStop was never worth $450+ per share. It probably isn’t worth $20 per share. We haven’t witnessed the complete ride yet, but the stock is back down to around $50 and there are few buyers except some inexperienced traders hoping for another ride.
That doesn’t mean short squeezes are over. The new targets are small biotech names. But the saga is the first real reminder during the rising period of speculation that it can be just as easy to lose money as it is to make money.
With that said, the rise in speculation is an overlay on an economy gathering strength. Covid-19 case counts are falling, as are hospital and ICU admissions. To be sure, case counts are still elevated, and new strains add to health risks. But with the weather about to start getting warmer within a few weeks and more and more Americans, especially those at most risk for serious consequences getting vaccinated, life is going to start to get back to normal in the Spring. Covid-19 may not go away entirely so fast. We will see a lot of mask wearing for months or maybe even longer. But by Summer, there will be more airline travel, more vacations, and a return of crowds at sports stadiums, albeit with some capacity restrictions. GDP in 2021 is going to grow by 5% or more. The pending spending bill in Congress will only add to the growth.
You see this play out in the stock market. Airlines are surging. So are many conventional in-store retailers. Banks are rising on the expectation of more loan activity, a steeper yield curve, and higher rates. While parts of the markets act insanely, most of the market reacts in a proper manner.
Earnings will surge as the economy recovers. But will a surge in economic activity spark much stronger than expected inflation? That is the ultimate big question. So far, the reaction has been muted. Commodity prices have been rising sharply, but they are a relatively minor component of the inflation mix. Wages and rents dominate, and both remain well contained. But both bear watching. The unemployment rate is back down to 6.3% and falling rapidly. New job postings are starting to rise. Rents have weakened as city dwellers opt for suburban homes. But as home prices surge, can rents stay down? Certainly not forever.
Conventional wisdom is that a surge in inflation expectations is a concern for 2022 or later. 10-year Treasury yields remain low, at about 1.2%. The Fed is using all its tools to keep rates low as long as possible.
I said at the end of last year that I expect the first half of 2021 to be a better environment for equity investors than the second half. Year-over-year earnings comparisons will be easiest in the first three quarters of the year. Excess capacity, both in manufacturing and labor, should keep inflationary pressures muted for at least the next several months. But as unemployment gets back below 5%, and the animal spirits of a post-pandemic world are released, concerns about future inflation will rise. At some point, the Fed will have to stop buying $5 billion of debt instruments every day. Congress shouldn’t keep passing spending bills without any new revenue sources.
Thus, the path of least resistance continues to be up. There will be speculative bubbles that inflate while this is happening, and some might deflate as well. SPACs are one obvious area where investors are getting too frivolous. One must also acknowledge that the money pouring into SPACs and IPOs has to come from somewhere else. Stock prices follow the same law of supply and demand as everything else. Thus, enjoy the ride but don’t lose your sense of balance.
Today, actress Laura Dern is 54.
James M. Meyer, CFA 610-260-2220