A Rally That Won’t Stop or a Bubble About to Pop
After a volatile yet profitable 2020, Wall Street is hoping for a calm — and still profitable — 2021. Not just hoping. Expecting.
Sentiment measures suggest that investors have seldom been more certain that share prices will rise. Excitement for what the year may bring explains why stock valuations are so high.
But is that justified? Or are these the sorts of extremes that indicate a bubble ripe for popping?
The economy and earnings are thawing from the deep freeze they were put in to control the coronavirus pandemic, and vaccines created faster than was thought possible are being distributed. But the impact of the pandemic may linger and change life in unforeseen ways, and at some point, the trillions of dollars of debt issued to prop up the economy will have to be reckoned with. And while the recent ratcheting up of political discord since the election has not slowed the rally in stocks, it may yet produce economic and societal consequences that erode confidence in the markets or in the United States as an investment destination generally.
One ominous development is that as stocks have soared in value, so have alternatives like government bonds. That could leave few places to hide for investors who decide that stocks are exorbitantly priced. The world may become safer, but the markets may be more perilous.
“In no case can you argue that U.S. stocks are cheap,” said Meb Faber, chief investment officer of Cambria Investment Management.
How expensive is the market? Very, based on a variety of measures. Earlier this month, it was worth 1.86 times the size of the economy, for example, well above any figure before the last few weeks.
“These things can go far further than anyone would expect because they tend to be self-reinforcing,” Mr. Faber said. “The problem with markets is the more expensive they get, the more chance there is that they’ll have big, fat losses.”
For 2020, the fourth quarter especially, the gains were big and fat. The S&P 500 rose 11.7 percent in the quarter, leaving it 67.9 percent above the March 23 bottom. The index rose 16.3 percent for all of 2020, a year in which economic output is estimated to have contracted 3.5 percent and earnings 15 percent, according to Bank of America.
Mutual Funds
Highlights of mutual fund performance in the fourth quarter.
Leaders and Laggards
Stocks vs. Bonds
Among general domestic stock funds.
Average returns, by fund category.
12 MONTHS
4TH QTR.
LEADERS
12 MONTHS
4TH QTR.
+
+
+
+
20.7
17.0
6.8
4.1
%
+
+
+
+
17.1
15.6
3.2
2.2
%
Kinetics Internet
No Load
+
+
+
+
+
+
+
+
56.4
46.9
150.8
113.9
0.5
3.6
149.2
11.2
%
+
+
+
+
+
+
+
+
51.8
51.4
45.8
44.6
43.4
43.3
42.9
41.1
%
General stock funds
International stocks
Fairholme
Taxable bonds
Morgan Stanley
Inst. Inception
Municipal bonds
Shelton Green
Alpha
Growth vs. Value
Returns in the fourth quarter.
Hotchkis & Wiley
Mid Cap Value I
Growth
Blend
Value
+
30
%
Undiscov. Mgrs.
Behavioral Value
+
20
Baron Partners
Institutional
+
10
Invesco Small-
Cap Value Y
0
Large-cap
MiDcap
Small-cap
Sector by Sector
12 MONTHS
4TH QTR.
LAGGARDS
12 MONTHS
4TH QTR.
Financial
–
+
+
+
+
+
+
–
+
+
0.7
12.2
12.9
53.3
33.5
23.4
0.7
3.1
13.3
13.1
%
+
+
+
+
+
+
+
+
+
+
32.9
22.3
19.7
19.4
13.7
11.6
10.0
9.4
8.9
1.4
%
Frontier MFG
Global Plus Inst.
+
+
+
10.3
10.2
23.9
n/a
1.9
6.1
3.6
4.6
%
+
+
+
+
+
+
+
+
3.3
3.2
3.0
2.7
2.5
2.3
1.6
0.5
%
Natural resources
Frontier MFG
Global Equity Inst.
Energy
GQG Partners US
Select Qual. Eq.
Technology
PFG Amer. Funds
Cons. Inc. Strat. R
Communications
Health
Invesco
Exchange
–
+
–
+
Utilities
American Funds
Coll. 2024 529C
Real estate
CGM Realty
Consumer defensive
Multicurrency
American Funds
Coll. 2021 529C
Stocks vs. Bonds
Average returns, by fund category.
12 MONTHS
4TH QTR.
+
+
+
+
20.7
17.0
6.8
4.1
%
+
+
+
+
17.1
15.6
3.2
2.2
%
General stock funds
International stocks
Taxable bonds
Municipal bonds
Growth vs. Value
Returns in the third quarter.
Growth
Blend
Value
+
30
%
+
20
+
10
0
Large-cap
MiDcap
Small-cap
12 MONTHS
Sector by Sector
4TH QTR.
Financial
–
+
+
+
+
+
+
–
+
+
0.7
12.2
12.9
53.3
33.5
23.4
0.7
3.1
13.3
13.1
%
+
+
+
+
+
+
+
+
+
+
32.9
22.3
19.7
19.4
13.7
11.6
10.0
9.4
8.9
1.4
%
Natural resources
Energy
Technology
Communications
Health
Utilities
Real estate
Consumer defensive
Multicurrency
Leaders and Laggards
Among general domestic stock funds.
LEADERS
12 MONTHS
4TH QTR.
Kinetics Internet
No Load
+
+
+
+
+
+
+
+
56.4
46.9
150.8
113.9
0.5
3.6
149.2
11.2
%
+
+
+
+
+
+
+
+
51.8
51.4
45.8
44.6
43.4
43.3
42.9
41.1
%
Fairholme
Morgan Stanley
Inst. Inception
Shelton Green
Alpha
Hotchkis & Wiley
Mid Cap Value I
Undiscov. Mgrs.
Behavioral Value
Baron Partners
Institutional
Invesco Small-
Cap Value Y
12 MONTHS
4TH QTR.
LAGGARDS
+
+
+
10.3
10.2
23.9
n/a
1.9
6.1
3.6
4.6
%
+
+
+
+
+
+
+
+
3.3
3.2
3.0
2.7
2.5
2.3
1.6
0.5
%
Frontier MFG
Global Plus Inst.
Frontier MFG
Global Equity Inst.
GQG Partners US
Select Qual. Eq.
PFG Amer. Funds
Cons. Inc. Strat. R
–
+
–
+
Invesco
Exchange
American Funds
Coll. 2024 529C
CGM Realty
American Funds
Coll. 2021 529C
Stocks vs. Bonds
Average returns, by fund category.
12 MONTHS
4TH QTR.
+
+
+
+
20.7
17.0
6.8
4.1
%
+
+
+
+
17.1
15.6
3.2
2.2
%
General stock funds
International stocks
Taxable bonds
Municipal bonds
Growth vs. Value
Returns in the third quarter.
Growth
Blend
Value
+
30
%
+
20
+
10
0
Large-cap
MiDcap
Small-cap
12 MONTHS
Sector by Sector
4TH QTR.
Financial
–
+
+
+
+
+
+
–
+
+
0.7
12.2
12.9
53.3
33.5
23.4
0.7
3.1
13.3
13.1
%
+
+
+
+
+
+
+
+
+
+
32.9
22.3
19.7
19.4
13.7
11.6
10.0
9.4
8.9
1.4
%
Natural resources
Energy
Technology
Communications
Health
Utilities
Real estate
Consumer defensive
Multicurrency
Leaders and Laggards
Among general domestic stock funds.
LEADERS
12 MONTHS
4TH QTR.
Kinetics Internet
No Load
+
+
+
+
+
+
+
+
56.4
46.9
150.8
113.9
0.5
3.6
149.2
11.2
%
+
+
+
+
+
+
+
+
51.8
51.4
45.8
44.6
43.4
43.3
42.9
41.1
%
Fairholme
Morgan Stanley
Inst. Inception
Shelton Green
Alpha
Hotchkis & Wiley
Mid Cap Value I
Undiscov. Mgrs.
Behavioral Value
Baron Partners
Institutional
Invesco Small-
Cap Value Y
12 MONTHS
4TH QTR.
LAGGARDS
+
+
+
10.3
10.2
23.9
n/a
1.9
6.1
3.6
4.6
%
+
+
+
+
+
+
+
+
3.3
3.2
3.0
2.7
2.5
2.3
1.6
0.5
%
Frontier MFG
Global Plus Inst.
Frontier MFG
Global Equity Inst.
GQG Partners US
Select Qual. Eq.
PFG Amer. Funds
Cons. Inc. Strat. R
–
+
–
+
Invesco
Exchange
American Funds
Coll. 2024 529C
CGM Realty
American Funds
Coll. 2021 529C
By The New York Times | Source: Morningstar
Some investment advisers find the elevated valuations worrisome; others are comfortable with them.
Jeremy Grantham, long-term investment strategist at GMO, contends that stocks are in a “fully fledged epic bubble.” In a commentary published on his firm’s website, he highlighted the market’s “extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior,” and predicted that “this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
Charles Kantor, manager of the Neuberger Berman Long Short fund, disagrees. Holders of such views, he said, “meaningfully understate where earnings will be at the end of the year” as the pandemic abates and life gets back to normal.
“People are going to return to restaurants and movie theaters and vacations,” he said. “The pent-up demand for experience will be overwhelming.”
That, in turn, will drive a new round of capital investment by businesses, accelerating growth, Mr. Kantor said.
His advice to investors is to “watch out above, not watch out below,” he said. “There’s a lot to be optimistic about. Five years from today stocks would have produced a reasonable return because today’s starting point on earnings, we’ll come to believe, is too low.”
Simeon Hyman, global investment strategist at ProShares, also expects strong corporate performance to alleviate the apparent overvaluation of stocks. He cited estimates for 2021 earnings that would give the market a price-to earnings ratio of 22, compared with its present multiple of about 30 based on earnings reported for the last year.
A 22 ratio would still leave stocks far more expensive than the long-term average of just under 16, though, and it would take a 36 percent earnings jump this year — without any further share price increases — to get to a 22 P.E. in the first place.
Mr. Hyman acknowledged that “there’s no great low-hanging fruit,” but added, “I don’t think you can say there’s anything crazy going on.”
The rise in earnings he envisions is feasible if profit margins recover all of the losses experienced last year, he said, and if the macroeconomic backdrop, particularly a continuation of very low interest rates and improving consumer spending, is favorable.
Latest Updates
Those are big ifs, however, and some of those developments may be incompatible with one another. Matthew Benkendorf, co-manager of the Virtus Vontobel Global Opportunities fund, admonished bulls for using “dangerous logic” to build a case for buying stocks that, he said, makes sense only with an ideal mix of normally antithetical conditions, such as strong economic and corporate performance with inflation and interest rates that remain very low.
Aid from the Federal Reserve and Congress, and the promise of more to come, has allowed stocks to soar, even during a recession, as investors anticipate an eventual recovery. But the returns will diminish, Mr. Benkendorf said, as the boost to growth eventually becomes more muted or the bond market demands higher yields as the mountain of government debt grows.
A stubbornly subdued and artificially supported economy could bode ill for stocks, but so could an economy that recovers for real, he warned.
“At some point, the economy has to do well, but that means higher interest rates,” he said. “How long can we linger in this perfect Goldilocks scenario? There are headwinds either way.”
Fund owners had the wind at their back in the fourth quarter and for most of the year. The average domestic stock fund rose 16.8 percent in the quarter and 19.7 percent for all of 2020. The best performers in the fourth quarter were specialists in financial services, natural resources and industrials. Each rose more than 20 percent on average, as did portfolios focused on small and midsize companies.
International stock funds were up 15.6 percent in the quarter and 17 percent on the year.
Bond funds were strong, too, rising 3.2 percent for the quarter and 6.8 percent for the year. High-yield and emerging-market portfolios excelled in the fourth quarter, while ones that hold long-term government instruments were standouts for the full year.
One possible sign of a bubble is a belief that negative developments are somehow positive. That interest rates seem destined to rise no matter what, worsening the outlook for bonds, is the foundation for an idea gaining currency among bulls: Buying stocks when they’re so expensive makes sense because bonds are expensive, too.
Anyone who spends $1,000 on a 10-year Treasury bond, yielding about 1 percent, is willing to tie that money up for a decade and be paid $100 total in coupons in the meantime before getting the original investment back.
But does a poor outlook for bonds make the outlook good for stocks?
John Hussman, president of Hussman Investment Trust, noted that high stock valuations tend to coincide with low bond yields. But valuations in the neighborhood of today’s have historically and reliably led to very low long-term stock returns, all the same.
“When both assets are at extreme valuations, this comparison, at best, says only that the dismal expected return on one asset is expected to exceed the really dismal expected return on the other asset,” Mr. Hussman said in a note to the firm’s investors.
He foresees a 1.8 percent annual loss in the S&P 500 over the next 12 years and a 0.9 percent annual gain for 10-year Treasuries.
Investment advisers generally aren’t that gloomy. Even the cautious ones find niches that they expect to offer a decent risk-reward balance.
Mr. Kantor expects companies that have done well during the pandemic to press their advantage, including Visa, Amazon and UnitedHealth. He views these as “businesses that will continue to prosper when business returns to normal” because of their “technology, scale, clean balance sheets and knowledge of their customers.”
Mr. Hyman advises rotating into high-quality stocks that have underperformed during the rally, including those of companies with strong dividend growth. He also likes high-yield bonds and shares of smaller companies, whose prices have doubled from the March lows but have underperformed over longer periods.
Saira Malik, head of equities at Nuveen, also favors smaller companies, which she said “could continue to outperform as the world reopens.” She also recommends financial and health care stocks, and high-quality tech stocks that have lagged their peers, including Alphabet, the corporate parent of Google.
Ms. Malik finds opportunities overseas, too, particularly in “deep-value emerging markets,” such as Brazil and others in Latin America that have been especially hard hit by the pandemic.
“We’re looking for areas that have lagged due to Covid-19, not outperformed due to it,” she said.
Mr. Benkendorf is another fan of stocks in emerging markets, which he called “a very bright long-term story, still.”
“Emerging markets have begun a good catch-up game,” he said. “The development story is much clearer. There is incremental growth to come.”
International stocks of all sorts appeal to Mr. Faber.
“The bad news is the U.S. is expensive, the good news is the rest of the world is pretty reasonable,” he said. To stay out of trouble, his advice is to “diversify into foreign, tilt more into value stuff, and have realistic expectations.”
Source: Read Full Article