Crown Investment Committee: The Party is in Full Swing

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The first quarter of 2021 was full of tensions, dramatics and enthusiasm.  In the end we saw the S&P 500 finish up 5.8% while 10-year US Treasury bonds went out with a 1.7% yield after starting the year at 0.90%, according to Bloomberg data.  Congress passed more stimulus in the form of a $1.9 trillion recovery package and the Federal Reserve Bank promised low rates for the foreseeable future.

Energy and financial sectors which lagged badly in 2020 are the top performing sectors in 2021.

The top five market capitalization names lead by Apple, Amazon, Alphabet, Facebook and Microsoft represent 22% of the S&P 500 and continue to demonstrate strength after a recent hiatus.

Stocks and commodities are outperforming bonds as rates climb for long dated government securities. As rates go up, bonds with long maturities go down in price.  High yield bonds with lower quality credits are doing well, as are floating rate notes.  Rising long yields indicate stronger economic activity and the end of deflation.

Speculation is raging in certain areas of the market.  New issues are raising serious amounts of new cash via IPOs and SPACs. SPACs are a new way for entrepreneurs to raise money first then buy assets.  Low quality speculative names led the winners list along with small capitalization value stocks.

The economy is set to surge for the rest of 2021.  Money continues to pour into both stocks and bonds from both domestic and foreign investors.

Individuals are getting more positive as the market rises as measured by AAII bullish readings above 50%, the first above the mark we have seen in years.

The Fed is forecasting 6.5% GDP growth in the U.S., which already would be the strongest year of growth since 1984 according to the IMF.  Some analysts are projecting double digit growth.  Inflation is forecast to rise past the 2% Fed target zone.  Unemployment has gone down to 6% from 16% last year, according to Fed data.

As the global economy rises from the Covid abyss, consumers are flush with cash and businesses have become more efficient.  Companies on the precipice last year can easily raise money now.  Profits drive stocks along with money flows.  Both are rising.  Earnings for 2021 may jump as much as 16% versus last year, according to FactSet.

The S&P 500 just crossed the 4,000 level for the first time ever which reflects investor’s optimism for the economy.  Valuations are stretched with the 12-month P/E ratio for the S&P 500 at 21.9x, according to FactSet.  This is far above the 5-year average 17.8x and the 10-year average 15.9x.   The bulls forecast a 4,300 target by year end.

Serious concerns about Covid stalling economic progress are fading as vaccines get distributed across the USA at a strong pace.  The rest of the world is envious over our vaccine availability and rapid distribution.  European countries are still struggling with lockdowns and lack of vaccine availability. Despite these concerns, much of Europe is seeing rising stock markets even as negative interest rates in Germany, Switzerland, Netherlands and France become less negative.

Many wonder how long good times can last while others see blue skies ahead.  What can go wrong with an easy Fed, a free spending Congress and a recovering economy?

Poorly managed states with big budget problems, such as IL and NJ are being bailed out by the Federal government.  Concerns over future inflation and tax increases to pay for increased government spending are being ignored for the time being.  New infrastructure bills are being considered, which may add another $2 trillion into our national deficit.

Much remains unknown about pending tax legislation, but taxes are sure to rise.  Interest rates paid on long dated bonds will rise too.  Inflation prospects over the near term may spook investors as large deficits are not as manageable when rates of interest go up.

Markets normally overshoot at tops and bottoms as emotional reactions play heavily.  Fear and greed take over rational analysis as prices drop or soar.

Stocks currently have high valuations by historical measurements such as P/E ratios and market capitalization versus GDP.  Interest rates are much lower now than in the past, increasing stock valuations.  Should interest rates increase rapidly those P/E ratios shrink and values of stocks fall without other offsets such as higher earnings.

We may soon enter a blowoff stage for the broad market.  We have already witnessed similar pullback periods in meme stocks, SPAC issuances, and 2020 rapid growth names like Peleton, Teledoc, Tesla and Zoom.  This isn’t 1999 but we do have concerns.

We continue to monitor trends and prices.  We cannot foresee the future.  We will however make rational decisions given new facts on the ground.  We believe the bulls will continue to have control for the near term.  Many new opportunities arise as prices swing.  Know we are watching and weighing many factors to aid you in meeting your financial goals.

If you have questions or desire for a meeting by phone or Zoom we will be happy to set one up.  As we all get our vaccines and spring leads to more openings, we hope to meet you in person as well.

All the best.  Stay safe and enjoy the current improved environment.

Doug Coppola - Investment Committee Chairman            Steve Lindgren - Chief Investment Officer