Stocks finished marginally lower in mixed trading yesterday. Bond rates were little changed.
Yesterday’s front page showed a lot of turmoil. The aftereffect of a major hurricane was creating havoc from the Gulf coast to the Northeast. Controversy about the U.S. exit from Afghanistan continued to dominate the news headlines. A huge wildfire took dead aim on South Lake Tahoe. Texas lawmakers finally passed one of the more restrictive voting laws. Elizabeth Holmes went to trial for allegedly perpetuating one of the biggest frauds in the venture capital community. And the stock market yawned. Why? Because most of these events have little apparent long-term economic impact. Perhaps our less-than-tranquil exit from Afghanistan will impact Chinese, Russian or Iranian behavior in the future, but for now speculative consequences are not impacting the stock market.
It was also August, a time of vacation, few earnings reports and not a lot of economic news. But now September starts. Futures are pointing a bit higher in very early trading. There are some employers who fund 401k plans on the first of each month. We will start to see August auto and manufacturing data today and tomorrow, but the big economic news will be Friday’s employment report for August. After two months of 900k new jobs created, this one is likely to be impacted by both vacations and the spread of the Covid-19 Delta variant. What may be most telling are trends on wages.
The overall dominating factor is the Fed, which continues to buy $120 billion of bonds every month. While that is likely to be reduced once the Fed starts tapering later this year, it isn’t tapering yet. If you want to get an idea of the impact the Fed continues to make, look at the speculative fringes of the market. I mean crypto currency, meme stocks, SPACs, etc. They continue to trend higher. None, and I mean none with a capital N, have any substantive intrinsic value. That doesn’t mean their prices are doomed, at least not in the near term. As more excess money sloshes around, it seeks a home. Cash and money market funds provide no returns. Some of that excess moves slowly up the risk latter into stocks, bonds, or real estate. It pushes prices up but not into the stratosphere. At least not compared to the speculative fringes. As more and more investors have success betting on Bitcoin or GameStop, more money follows. That is what happens as speculation morphs toward euphoria.
I have little doubt that whenever the next recession or bear market happens, stocks selling at ridiculously inflated levels will find their way back to earth. The teenagers with $500 Robin Hood accounts will go back to playing video games, or betting via fantasy leagues, but until then, excess money rules.
That doesn’t mean speculation is risk-free. On Monday, Zoom reported decent earnings, maybe even more than decent, but its forward guidance suggests business is flattening out. To rational thinkers, this shouldn’t be a huge surprise. There is a place in this world for Zoom, even after the pandemic ends. Families can connect easily. We at Tower Bridge can see our out of town clients more easily. But the growth rates are going to slow. Even after yesterday’s 10%+ decline, the stock still sells at 60 times expected earnings two years from now. And those estimates are barely 10% higher than today. What will this stock sell for in the next bear market? Given today’s fundamentals, I would say a lot less. That doesn’t mean it will sell for 10% or less a couple of months from now, but when the excess money gets absorbed as the Fed drops less from helicopters while the economy continues to grow, speculative fever will subside. If interest rates rise in the future, speculative fever will subside. Until then, don’t ever ask a rational investor when speculative fever reaches a crescendo. I have no idea. As long as the Fed keeps feeding the markets, I wouldn’t bet on today.
Back to fundamentals, earnings are growing, maybe not at the same pace as the first half of this year, but still at a very healthy pace. Interest rates remain low. Until that scenario changes, stocks should be favorable investments. September can be a volatile month, and after Friday’s employment report there are no obvious news stories until the FOMC meeting culminating on the 22nd. Hopefully by then, the new Delta variant cases will be on the obvious decline nationally. Looking toward the fourth quarter, the only obvious economic impediment will be supply chain constrained shortages that continue. As for indicators to watch, as always, any sudden move in 10-year Treasury yields can be market moving. Finally, during September details of the Biden economic plan will be revealed. We all know how the Democrats want to spend money. Now we must see the hard part, how they plan to pay for it. While the tax proposals will be aimed directly at the investor class, the one most important to earnings and stock prices will be the corporate tax rate. We know the original ask is likely to be 28%, an increase of one-third. We also know that anything over 25% is a non-starter. Depending on how far the spending proposals are cut, 25% may not survive either. The Democrats need every vote in the Senate and can only lose 3 in the House. They are not a homogeneous majority. Most Capitol Hill observers believe the ultimate bill will be cut in half from original asks of close to $5 billion. How the proposals shape up could be market moving over the next month, especially amid the absence of other key economic news.
Today, Dr. Phil is 71. Barry Gibb turns 75. Lily Tomlin is 82.
James M. Meyer, CFA 610-260-2220