Friends & Partners,
I hope you had a relaxing holiday, most of us certainly were due to unplug for at least a few days. The one thing that WFH has seemingly brought some of us is the inability to separate work time from our personal and family time, so a conscious effort on this front is important to consider. As we move into 2021, things remain difficult, but there is much hope on the horizon. I’m releasing this month’s note early in the month as we embark on a new year and there remains much to consider and address – I wish you only health and success in 2021.
There still remains significant confusion over how the markets remain so robust while the virus ravages the economy, so I will touch upon that in this month’s note. Most strategists and pundits expect a strong 2021 overall, and I wouldn’t disagree with that general call. As usual, we will get bumps and pullbacks along the way, and there are always risks lurking – we are positioned for these, and will continue to remain so. In last month's note, I touched upon inflation being a risk that could upend markets, and it also remains possible that a third wave of infections emerges in the spring as happened during the 1918 flu pandemic which could also delay a return to normalcy. Sentiment remains very bullish overall (a contrarian indicator and often a warning sign), as does sentiment around vaccines, but there could of course be bumps in the road with vaccine rollouts, distribution/execution, unexpected side-effects, as well as efficacy with new strains and mutations of the virus. However, the virus could also start to retreat on its own as the weather shifts. Bottom line is that the commitment to keep interest rates low and Quantitative Easing into 2022 at a minimum remains the main tailwind for risk assets (stocks, bonds, real estate, commodities). But further upward pressure on inflation and/or a disorderly rise in yields remains the main risk to this positive medium and longer-term outlook for markets at this point in my view. Upcoming pullbacks are unlikely to prove to be bearish game changers longer term however, so we will be positioned to capitalize accordingly.
The Stock Market Isn’t the Economy (Well, Not Exactly)
In the US and Canada, small businesses drive almost half of economic activity and private sector employment, and 2/3rds of net new jobs. Public companies on the other hand only represent 1/3rd of US employment. So, the stock market arguably fails to reflect this hugely important part of the economy, and the part that we personally ‘feel’ day to day, so it affects our ‘biases’ as well.
Also consider that the S&P500 is a market cap-weighted index, where the big 5 tech names represent almost a quarter of this index (Microsoft, Apple, Google, Amazon and Facebook). 44% of its weight is concentrated in Big Tech (technology and communication services), and the top five sectors comprise almost 70% of its weight. So, the tech/growth names are moving this index in large part, and these names are benefiting from the stay at home measures as we know, while small businesses are getting crushed by it as a rule. So, the S&P500 companies often fail to capture the economic realities of many private companies in large parts of Canada and the US.
The stock market is also forward looking – things may feel bad today, but in the long-run for an established company, the current slowdown may well be a ‘blip’ (assuming it can withstand the short-term pain). The stock market usually leads the economic cycles, so is currently reflecting a return to normalcy in due course. Following is a good chart showing this:
Of course, there are always risks to markets as I’ve discussed. However, central banks are also almost certainly going to maintain their exceptionally accommodative stance as the renewed wave of COVID plays out, mitigating some of the near-term risks.
Growth Stocks Have Crushed Value Stocks for Years, Is that About to Change?
In short, there are a number of reasons to believe that value stocks may finally play a bit of catch-up with the growth names that have outperformed for years now. At a minimum, I believe it is prudent to have some exposure to value stocks as we move into 2021. Note the following points on this:
- Monetary easing is off the charts = value stocks lead
- Cyclicals have proven resilient, and retooled business models, costs, and processes = operating leverage and lower risk premia = higher valuations for value stocks
- Continued shift to de-urbanization is asset heavy (people buy houses, cars, etc) = value stocks benefit
- Real interest rates will remain negative for quite some time (most negative in over 60 years) = cost of borrowing remains extremely low = real asset boom = value stock tailwinds (since 1960, Value stocks outperform Growth stocks when real rates are in the lowest decile, which they certainly are now)
- Growth stocks are arguably expensive, especially compared to value stocks. On a relative basis, the valuation gap between the two styles has reached extremes not seen since the late 1990s (see chart below)
A durable shift to value leadership will likely require more evidence of a self-sustaining economic recovery, rising inflation and pricing power, and a steepening yield curve. These are all looking more likely, and investors can potentially outperform over the next few years with some exposure to a combination of cyclical, value, small caps and non-U.S. stocks.
And things can shift quickly on this front, so we need to be and are positioned for this potential scenario…
We Can’t Possibly Invest at These Highs, Can We?
The million dollar question – we all want to buy low and sell high, though few pull that off consistently. If you’re hesitant, it’s prudent to average-in: but we don’t want to be completely in cash and out of the market 100% for long if that’s a position you’re in. Timing is a fool’s errand as a general rule, and I can send along lots of research to back that up. For an extreme example, let’s take a look at how you would have done in the past had you only invested at all-time highs in the S&P 500 Index from 1950-2020 – the returns are not too far off those had you averaged in every day:
Wealth Management Alpha
This month, I’ve attached a concise piece that summarizes some strategies to minimize taxes, as well as build and protect wealth – it touches on risk management, vacation home planning, incorporating various trust structures, family income splitting strategies, and succession planning. These concepts are high level and get much more in-depth, but it speaks to the value of working with an advisor and institution that can help you and your situation. If you’d like to discuss anything in further detail, I’m here to help.