Follow-ups and New Thoughts:
1) November Employment Report
The number of jobs created in November (210,000) may have been a disappointment but I believe there are big questions about how that measure accounts for home businesses. Unemployment claims keep falling and the household survey is up over 1.1 million, so that the implication is lots of people are working but not receiving paychecks per se. The upshot is that the evolving narrative of a faster taper has not been negated by the payrolls figure. A faster taper, if it occurs, is most detrimental for high P/E securities. Second tier growth stocks, especially in long dated industries like biotech and fintech where companies are not yet seeing positive cash flow, are faring the worst these days as a result.
2) November CPI
Inflation remained at relatively high levels in November. Core CPI, at 4.9%, is the highest in over 30 years – and, because of the way owners equivalent rent is calculated, might well be understated. Bond yields responded to this information by FALLING! I have to believe that in the days and weeks to come that this move will be reversed; traders might have been braced for even worse numbers.
Typically, the stock market does well in November and December. We are usually ramping up out of the September/October economic slowdown and as we approach the new year, analysts start focusing on the next year’s earnings estimates. In the past, positive seasonality has been superseded by negative liquidity developments, as happened in 2000, 2008, 2015, and 2018. We are flirting with that in 2021 too, as the market awaits announcement from the Fed (December 15th) whether the taper timeline will be sped up or not. Again, valuations of growth stocks are sufficiently high such that a negative surprise in this matter would almost certainly be problematic.
4) Biotech on Sale
Perhaps no area of the stock market has done poorer over the last few months than biotechnology. ARK Genomic Revolution is down almost 50% from its early February highs, with the decline accelerating after Labor Day. Clearly the sector got way ahead of itself early in the year as the Covid vaccine showed the promise of mRNA technology and investors believed that many new cures and therapies were on the verge of being revealed. Unfortunately, it hasn’t played out that way. The FDA has so prioritized COVID that other therapies are being ignored for the time being. Investor patience with firms that are currently losing money (as most biotechs do) seems to have run out. Yet it is difficult to believe that this won’t be a leading sector over the next 10-20 years as our understanding of our individual genetic make-ups increases. Buying biotech today looks like the proverbial “catching a falling knife” attempt, but I believe this sector may be a good opportunity for aggressive (but patient) investors.
5) Poor International Stock Performance
We are on the verge of concluding yet another year where the promise of greater returns from outside the U.S. went spectacularly unfulfilled. As of the end of November, the U.S. stock market has edged non-U.S. by a mere 17.3%[i]. Sarcasm intended. Every year it seems like the brightest investment minds note that foreign markets are far cheaper than U.S. markets and thus set to outperform in the year ahead but every year that doesn’t happen. Clearly, other forces are at work. According to Statista, the U.S. represents about 56% of global stock market capitalization. That is actually a higher percentage than 5, 10, 20, and 30 years ago. We have underweighted international stocks from Day 1; our average equity portfolio is about 72% U.S/28% foreign. And yet I still wonder if I shouldn’t have even less overseas exposure until something changes. It doesn’t seem like a country representing about 4.5% of the world’s population should hog the lion’s share of its equity returns year after year, but here we are.
6) Emerging Markets
On the subject of poor international performance, I’m trying to determine whether or not Europe or Emerging Markets are more disappointing. Europe doesn’t grow, while emerging markets grow and then spectacularly collapse, giving all of their investment returns back. Case in point this year is China, which gained 20% from the start of the year to February 17th. From that point, it has surrendered 35%. We can and have reduced our China exposure but the question always comes down to – where do you put it? Some of the fastest growing emerging market countries have stocks that have risen and declined very sharply, such as Argentina’s Mercadolibre and Singapore’s Sea Ltd. India has been on a very strong roll lately, but can that be trusted? One of the odd things about emerging markets is that smaller countries may actually be safer because they tend to stay out of the government’s crosshairs and are less susceptible to the boom-bust of foreign investment.
7) Strength of the US Dollar
In retrospect, a great trade in 2021 would have been to sell all bonds and buy the US dollar ETF (UUP). It has returned 6.35% year to date, surpassing all categories of bonds including TIPs. It yields nothing; one simply receives the difference between the value of the dollar and a basket of foreign currencies. Because the U.S. dollar is the highest quality currency that has at least some yield to it, it continues to attract inflows from foreigners. It is overvalued on a purchasing power parity basis, so when (if) the global economy recovers, you would not want to own it as its long term expected rate of return is the T-bill rate less fund expenses.
8) In FAAMG We Trust
Investors want growth because interest rates are low. Investors want pricing power because inflation is a concern. Investors want quality because tapering will reduce liquidity, meaning companies that need to borrow are more vulnerable. FAAMG (Should it be GAMMA now that Facebook has become Meta?) provides all the things investors want. Plus, one of the fastest growing sectors of the equity market is hedged equity, which is essentially FAAMG with an options overlay. When the tide finally goes out here (and I have no idea when this will happen but it IS inevitable), it may take a decade to work off the overvaluation. Consider the spectacular underperformance of the S&P 500 from 2000 through 2010.
Chart 1: S&P 500 now more concentrated in the 5 largest stocks than ever
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[i] Per Morningstar, the S&P 500 was up 23.18 through November versus 5.84% for MSCI EAFE.