February 2021 - A Frenetic Start
By Kyle M. McBurney, CFP
Managing Partner at Highland Peak Wealth
Well, looking at the numbers, one can only assume it was one dull January. At market close on Friday, a fully diversified portfolio barely budged from start to finish. A 1% pullback in the S&P 500 was offset by continued strength in small-cap and emerging market stocks. Did I miss something interesting? I suppose outside of a stunning run-off election in Georgia, a violent protest at the Capitol, the inauguration of a new President with no crowds in attendance other than soldiers, and a market-rattling short squeeze, it was a totally uninteresting start to the year.
I joke, I joke. Despite January taking a page from 2020’s chaos instruction guide, stocks remained resilient, with indexes setting several records throughout the month. It looked like a positive sweep across the board until the final week hit - U.S. stocks fell sharply on Friday, closing out the worst week for stocks since October. The final week of January felt a little bit like a seesaw, lifted by stimulus optimism, only to be discouraged by recurring coronavirus concerns and frenzied trading activity. If January is any indication of the rest of 2021, it won’t be a boring year.
On the positive side, small-Cap and emerging market stocks were stellar in January. Despite last month’s noisiness, this development should not be pushed aside. Typically considered the “riskier” part of a well-diversified portfolio, strength in small and emerging market stocks communicates an optimistic market confident in future economic growth. As these stocks move, the rest tend to follow. Also, when these economically sensitive stocks and bond yields rise together, it often signals the classic reflation trade foreshadowing a full-fledged economic recovery.
Otherwise, we are aware of elevated market valuations and associated short-term risks. It certainly wouldn’t stretch our imagination to see a market reset early in 2021, especially following such a massive rally in Q4. More on this later, but we will likely view any market pullback as an opportunity to pick up some outstanding companies and sectors. Of course, we will keep you updated along the way. The greatest threat to any bull market is typically the Federal Reserve interest-rate increase, and that doesn’t appear likely for at least another year or two.
Frenzied Trading
Over the past week, we have received numerous questions around last week’s trading activity. I won’t get into the weeds on this and will instead keep the big picture in mind. This story started as an exciting sideshow and has since morphed into a cultural spectacle. I did not plan to include this subject in my newsletter, but when your barber starts asking about it, best to address the elephant in the room (yes, I braved the barber).
I will stay away from comments around regulation and this notion of David vs. Goliath. For the time being, we see last week’s events isolated to a small group of stocks - a consequence of free commissions, more free time, and a new round of stimulus checks looking for a home.
As previously stated, an important goal of this newsletter is to help discern noise from signal. To put it simply, this is the epitome of noise. Outside of perhaps a dozen or so stocks with extremely high short interest, this story has little impact on the broader market. There is a big difference between structural concerns and speculation glitches. Social media can make things seem more dramatic than reality. After all, retail trading only accounts for 15-20% of daily volume trading. Institutions still dominate.
However, I recognize that we cannot “un-see” last week’s events.
At the moment, markets have a real PR problem. When stories like this become mainstream, it is easy to view markets as a rigged game best left to the pros. I have heard this a million times and can certainly sympathize with frustrations over perceived market manipulation. Thus, I feel the true concern of these events lie in the deterioration of faith in our financial markets. Once trust is lost, it can be hard to gain back.
This is where I want to try and push back on some of the negativity. Below is an excellent breakdown by Dimensional Fund Advisors that examines how often the S&P 500 index is positive over a given timeframe.
Although it may feel like one, the stock market is the opposite of a casino. In a casino, the odds are stacked against you, and the longer the play, the greater the odds of leaving empty. It is the total opposite in the stock market – the longer you play, and the more patient you remain, the increased likelihood of a positive result. The market is too important and too impactful to walk away from.
Day to day, the market can feel like a coin flip. However, the long-term results speak for themselves. Even the worst annual return over 30 years in the history of the stock market would have produced a total return of more than 850%.
This is another great chart that we shared with clients leading up to the election -
This chart does an excellent job of summarizing two critical themes:
1) Over the long-term, market returns have been surprisingly steady
2) Markets don’t care who sits at 1600 Penn Ave
Focusing on stocks day-to-day can be an exhaustive ordeal. And yet, when you zoom out, it looks easy, doesn’t it?
This theme leads me to another important reminder – long term investing is boring. It can be as dull as ditchwater but remains as powerful as ever. As a Highland Peak Wealth client, there is no need to dabble in the volatile world of speculation. After all, many will likely be stuck holding preposterously overvalued shares, as they always are in bubbles.
A Quick Note on Stock Market Bubbles
Over the past month, there has been a surge in concerns of a stock market bubble. These apprehensions are valid, as one cannot ignore the tremendous amount of stimulus and liquidity that has been pumped into our economy. Also, last week’s market activity may unravel some old memories of the late 90’s tech bubble. See below.
Source: Strategas
However, these concerns are normal and healthy. For as long as I have been in the industry, bubble-mongering has been a routine process. It is far rarer to not see such hyperbolic comments while on CNBC or reading the Wall Street Journal. Here is a collection of inaccurate examples that have certainly not aged well:
December 27, 2019: U.S. stock market is a bubble (Forbes)
June 23, 2016: Uh oh. Is the stock market in a bubble again? (CNN Money)
May 6, 2014: Tim to worry about stock market bubbles (NY Times)
December 2, 2013: Nobel prize winner warns of US stock market bubble (CNBC)
March 27, 2012: Robert Shiller eyes another tech bubble (Yahoo! Finance)
Bubbles, and the act of calling a bubble, has become an American past-time. Eventually, these bubble-callers will be correct but will likely miss tremendous upside over the long run.
However, this is a contrarian indicator of sorts. It is hard to call it a bubble when everyone thinks/talks about it being a bubble. This idea’s same attention may be the best defense against an actual stock market bubble from forming and bursting. Typically, a bubble is created and ultimately popped when people are blissfully unaware of its existence. Blissfully unaware or perhaps painfully naïve. Look how low google searches were back in ’06 and ’07.
In summary, it is a flawed exercise to speculate on or try to time market bubbles. While we acknowledge that “micro-bubbles” currently exist in Tesla, Bitcoin, etc., it is hard to view the entire market this way. There are certainly parts of the market that are overvalued. However, there are many sections that we feel remain undervalued – value, small-cap, and international stocks to name a few.
A Peek at the 10-Year Treasury
The yield on the benchmark 10-Year Treasury rose above 1% for the first time since March, reflecting increased bets on additional stimulus after Georgia’s runoff elections. Savers rejoice!
Source: Strategas
First, a quick bond refresher - as bond yields rise, prices fall, and vice versa. To put it another way, when yields rise, it is a sign that more investors are selling their bond positions for riskier assets. When bond yields fall as they did last March, it reflects investors pouring capital into the safety and security of fixed income. To be a little cheeky, fixed-income traders have a bit of a vainglorious reputation, and tend to view themselves as more intelligent/more informed than stock market traders. Perhaps there is some truth, although there are many other factors involved. Either way, there is a notion on Wall Street that, for better or worse, fixed income traders get the joke before everyone else.
A push past 1% and the clear uptrend in yields is a positive indicator for stocks. While short-term predictive power is limited, the bond market is communicating an optimistic outlook for economic growth. The Georgia election sets up the outcome that many investors thinks will increase pandemic-relief efforts and potential infrastructure projects. Jeffries economists’ guesstimate $1 trillion in additional spending would add 2 percentage points to economic growth over the next two years. This would undoubtedly drive unemployment down more quickly and get growth rates back to target sooner.
**Treasury yields play a vital role in the economy – setting rates on everything from corporate bonds to mortgage rates. As such, for those who are looking to refinance, now is a great time to lock in fantastic rates. If this uptrend of the 10-Year Treasury is any indication, these low rates may not be around for much longer.
What we are Watching – America’s Savings Accounts
U.S. household income and savings rate rose for the first time in three months as a new round of government-aid kicked in. Household income – what we all received from wages, investments, stimulus – climbed 0.6%. Our collective income may increase further in early 2021 as Congress and the White House debate the merits of additional $1000 or $1400 stimulus checks. Hopefully, February will provide some further clarity.
On top of an increase in U.S. income and savings, consumer spending fell by 0.2%. After all, we are going out to eat less, seeing fewer movies and sporting events, not traveling, and saving more. Add it all together and Americans are currently enjoying a historically high savings rate that could boost future spending in the back half of 2021. Incredibly, the personal savings rate rose to 13.7% last month – the highest savings since 1975 and almost double pre-pandemic levels.
So, what does all this jargon mean?
1) There is still a ton of money on the sidelines
2) This liquidity rally still has legs
3) While market may pull back, plenty of opportunistic buyers remain
Allocation Update
Despite a peculiar January, we remain slightly overweight on stocks, with a continued focus on growth over value and U.S. over International. With the S&P 500 trading near 2-standard deviations above its 200-day moving average (wonky but important), it would not surprise us to see last week’s pullback persist for a little while longer (markets off to a strong start this week).Through it all, we continue to believe that 2021 will provide markets with the necessary level of economic growth. Healthy savings accounts and robust government spending this year will likely make any short-term softness short-lived. We continue to look for meaningful pullbacks in more cyclical sectors poised to improve as the economy reopens (think industrials, materials, and financials).
As I write this newsletter, my window has evolved from a picturesque winter scene to a dreary March-like downpour - bummer for the kiddo. And, of course, for my wife, the teacher. If you think kids love snow days, spend some time with a teacher! Although, I suppose kids in other parts of the state may have their snow day “stripped” in this new Zoom environment. I guess our virtual world giveth and our virtual work taketh.
Teddy truly embraced last week’s snowfall. While skiing didn’t work out (two-year-olds and skis don’t mesh, apparently), sledding has become a daily pastime. Thanks to the quality of LL Bean innertubes, Dad can breathe easy as his little one rips down the hill with the cool older kids.
As always, I welcome any and all thoughts and criticisms.
The opinions expressed herein are those of Kyle McBurney, CFP as of the date of writing and are subject to change. This commentary is brought to you courtesy of Highland Peak Wealth which offers securities and investment advisory services through registered representatives of MML Investors Services, LLC (Member FINRA, Member SIPC). Past performance is not indicative of future performance. Information presented herein is meant for informational purposes only and should not be construed as specific tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary, therefore, the information should only be relied upon when coordinated with individual professional advice. This material may contain forward looking statements that are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Referenced indexes, such as the S&P 500, are unmanaged and their performance reflects the reinvestment of dividends and interest. Individuals cannot invest directly in an index
CRN202302-278064