Stocks gained for the month of January but the week ended with substantial declines in major indices. While we’ve always maintained that stocks can correct at any time for any reason but the reasons for this week’s selloff caught many as bizarre and unexpected. More on that later. Our take is that the fundamentals of the economy remain solid and have not changed:
- We expect economic growth to accelerate in the second half of 2021 as vaccines are widely distributed and pent up demand takes hold.
- Earnings of many of the 2020 best stock performers have continued to grow substantially as Q4 earnings are being released.
- Household debt service ratios, at less than 10% of income, are near the lowest they have been in 40 years.
- Extremely low interest rates with an accommodative FED provides ample liquidity to grow.
- Continued fiscal support to the economy.
Adding to market uncertainty, new vaccine test results released late in the week were mixed.
- Novavax reported 90% efficacy against the original variant of Covid-19, 85% against the new UK variant but only 50% with the South African variant. Novavax is currently working on a booster to become more effective against the South African variant.
- Johnson & Johnson reported that it’s late stage trial of a single dose vaccine was 72% effective in the U.S., 66% in Latin America and 57% effective in South Africa, with 90% of cases reported in South Africa being the new variant. More importantly, of the over 44,000 people to receive the vaccine, while some contracted Covid, not a single person died.
We believe that having more vaccines will help to greatly reduce the spread of Covid. Pfizer should have increased output in February and is contracting with Sanofi to help manufacture even more vaccines.
What really drove market volatility this week is the apparent mania of some retail investors fueled by Reddit social media, bidding up shares of small money loosing companies with large short positions. Those stocks soared causing the short sellers to buy shares to cover, causing more small retail investors to jump in.
What we are seeing in these few stocks is a classic bubble where more people buy as the price goes up. The 1637 tulip mania comes to mind. The astronomical valuations on these small struggling companies will never improve to the point to justify these prices. While there are currently huge gains for these few stocks, mainly due to the unwinding of shorts, this will not end well for most of the small investors.
We know the media has spent a large amount of time covering this story which, in our opinion, has only heightened the mania. However, we do not see this as a problem with the markets overall. Looking at the majority of the stocks that have been rising, we see two good reasons for this. First, despite the pandemic, we’ve seen increasing earnings in many companies in areas such as technology, shop at home, work from home, automobiles and home building, to name a few. As stock prices are usually a multiple of earnings, prices typically increase at a faster rate than earnings. Secondly, the near zero interest rates have justified larger multiples on stock prices. The earnings yield is the inverse of the price to earnings (PE) ratio. Lower interest rates typically justify a lower earnings yield or, in other words, a higher price to earnings ratio. Of course, besides earnings the PE ratio is also based on price. Prices do fluctuate for a number of reasons. Overall economic outlook, forecasted earnings growth are a couple of logical reasons. However, prices are also subject to primal emotions such as fear and greed. The FOMO (Fear of mission out) mania has certainly driven these handful of stocks lately. However, eventually that will correct.
In the short run, this mania seems to have had an effect on the overall markets from people selling out of other solid but boring stocks or funds and chasing this bubble. In the longer term, we do not see this as hurting the overall markets.
We do believe there needs to be some actions taken to have prevented these bubbles in the first place. These current events have captured the attention of both parties in Congress and the SEC. At this point, we will not speculate on where this will go.
Treasury yields were mixed with the 30-year bond yield closing at 1.843% and the 10-Year note closing at 1.089%. Crude oil rose to $52.23 a barrel while natural gas rose to $2.574 per MMBTUs. The U.S. dollar index rose to 90.55 and gold prices fell to $1846.60 an ounce.
In the economic numbers this week:
- The Case-Shiller S&P CoreLogic National Home Price Index for November showed home prices rose 9.5% from November 2019, up from 8.4% in October year over year.
- China’s National Bureau of Statistics Data reported
- Industrial output rose 7.3% in December from December 2019. This was up from 7.0% YTD through November.
- Retail sales rose 4.6% year over year in December, down from 5.0% in November.
- Fixed asset investment rose 2.9% in December from December 2019, up from 2.5% for the first 11 months.
- The Commerce Department reported:
- The U.S. economy grew at a 4.0% annual rate in the fourth quarter. This follows a 33.1% annual rate in the third quarter. However, for the calendar year 2020, gross domestic product shrank by 3.5%.
- Durable goods orders rose 0.2% in December from November.
- Nondefense capital goods orders, excluding aircraft rose 0.6%.
- Consumer spending fell 0.2% in December with autos and appliances falling the most.
- Household income rose 0.6%. This includes wages, investment returns and government-aid programs.
- Personal consumption expenditure (PCE) price index rose 0.4% in December following no change in November. Excluding volatile food and energy, prices rose 0.3%. From a year earlier prices have risen 1.3% and excluding food and energy, 1.5%.
- The personal savings rate in December at 13.7% was the highest since 1975 and much higher than the pre-pandemic 8% in February.
- The Labor Department reported:
- A seasonally adjusted 847,000 workers filed initial claims for unemployment in the week ending January 23rd. This was an decrease of 67,000 from a revised 914,000 the week before.
- The 4-week moving average, designed to smooth out volatility, was 868,000, an increase of 16,250 from the previous week’s revised average.
- Continuing claims fell from a revised 5.1MM to 4.8MM in the week ending January 16th.
- A broader measure of claims including extended benefits, pandemic assistance and other programs rose from 16.0MM to 18.3MM the week ending January 9nd.
- For the full report go here: https://www.dol.gov/ui/data.pdf .
- The EIA weekly oil report is here: http://ir.eia.gov/wpsr/wpsrsummary.pdf . Also, the EIA reported in the past week:
- Field production of crude oil was fell from 11.0MM barrels per day to 10.9MM barrels per day.
- Natural gas storage fell 128BN cubic feet and is above the average level at this time of year during the past five years.
- Baker Hughes reported the number of active oil rigs rose 6 to 295. The number of active natural gas rigs were unchanged at 88.
- Factset reported with 37% of S&P500 companies reporting that the blended earnings decline from Q4 2019 was 2.3%.
Please call us if you have any questions.
Loren C. Rex, CFP®, AIF®, MA Erik A Smith AIF®
President Managing Partner
Generations Financial Planning & Wealth Management 269-441-4143
77 E. Michigan Ave, Suite 140
Battle Creek, MI 49017
Carrie Fuce, Assistant 269-441-4091
Toll Free: 800-513-8180
Visit our Website: www.genfinplan.com
Registered Representative of and securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Generations Financial Planning & Wealth Management are separate companies and are not affiliated.
These are the opinions of Loren Rex and Erik Smith and are not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. The Indices mentioned are unmanaged and cannot be invested into directly.