Paulsen's Perspective
Get Used To Higher Valuations
In recent decades, U.S. companies have dramatically improved the profitability of labor. The implications for the valuation of equities have gone virtually unnoticed! An unprecedented surge in business-investment spending in relation to the overall economy—primarily driven by new-era technologies introduced since the early 1990s—shows evidence of substantially and, perhaps permanently, lifting the stock market-valuation range. If this proves correct, investors will eventually have to “Get Used To Higher Valuations.”
It’s Not Too Late… To Reduce Those Bond Holdings
As bond yields climb to their highest level of the recovery, we are all getting a glimpse of our portfolio future.
The Fed Is No Match For Real Earnings
As the new year begins, the Federal Reserve has taken center stage. Fears swirl around “when,” “how fast,” and “how much” the Fed may raise interest rates in 2022.
Is Omicron About To PAUSE The Bond Route?
As shown in the accompanying chart, since the very start of this pandemic, every significant change in the U.S. COVID-case count has “moved” bond yields in an inverse fashion. That is, until the last couple of weeks?
Confidence (Or Lack Thereof) Drives Stock Market Leadership
During the last year, real GDP growth was among the strongest of the post-war era, job creation was spectacular, wages rose by one of the fastest clips in almost 40 years, and annual retail sales grew by an astounding 18%. On top of that, housing activity was on fire, core capital-goods orders rose to a record high for the first time in more than 20 years, and corporate profits were unprecedented.
2022 Outlook?
As the Omicron variant ravages the country, we begin the New Year with a resigned realization that COVID is likely a part of our lives forever. We are vaxxed, masked, tested, distanced, and saddened by our shocking loss of loved ones! We are resolved to finally move beyond and pursue a new post-COVID normal, practice appropriate ongoing caution, and expect additional hardships. But we are also determined to return to our routines and again embrace aspirations, interactions, and the business of fulfilling lives. Although COVID will still be with us this year, Americans are poised for the pandemic to become endemic!
Will The U.S. Dollar Lose Its Safe-Haven Premium?
This year, the U.S. dollar played a significant role in the financial markets (Paulsen’s Perspective, December 10, 2021), and its movement in 2022 will likely prove equally important.
Forecasting the dollar is extremely difficult, and many would say it is a fool’s game. My personal experience predicting the greenback has not been particularly good, but a “fool” is rarely discouraged from trying again. Traditionally, U.S.-dollar outlooks are based on relative economic-growth rates (i.e., expected real U.S.-GDP growth compared to overseas), anticipated inflation rates, a comparison of relative monetary policies, and excess long-term yield spreads.
Sentiment Signal Suggesting First Quarter Rally?
Since September, the stock market has been periodically battered by renewed pandemic fears (Delta and now Omicron), increasing anxieties about pending Federal Reserve tightening, selloffs among popular new-era stocks, and ongoing concerns about high valuations and inflation. This has taken a toll on investor sentiment, as highlighted by several survey measures and market indexes.
Growth Or Value? It Depends More On The LEVEL Of Yields Than The Direction!
As the Federal Reserve turns more hawkish and expectations for higher interest rates mount, investors are lowering exposure to growth stocks. Typically, growth stocks exhibit a higher duration than value stocks because a larger proportion of their cash flows won’t be received until the distant future. Consequently, like longer-term bonds, growth stocks are generally expected to struggle when yields rise.
A Few Comforting Reminders
The stock market has been stressful of late. First, the S&P 500 had a rough autumn, declining by more than 5% from September to early October; after a brief recovery, stocks hit another sudden air pocket in late November. Both times, the VIX™ Volatility Index spiked above 20, and broader-market stocks suffered even steeper declines (e.g., small caps, cyclical stocks, and international investments).
Whether Thanks Or Blame Is Deserved… King Dollar Drove Your 2021 Investment Results!
To maintain sanity and protect fragile psyches, investment managers share a code. If results are good, it’s due to extraordinary foresight and skill. Whereas bad years are simply the product of unpredictable “bad luck.” In 2021, however, whether thanks or blame is deserved, “King Dollar” drove investment returns—as the following chart pictorial demonstrates.
A Small-Cap Dot-Com Valuation Replay?
As shown in Chart 1, the relative one-year-forward Price/Earnings (P/E) multiple of the S&P 600 Small Cap index is near the lowest level ever recorded since it was first introduced in October 1994. It is now as low as it was at the height of the dot-com mania when everything outside of tech stocks underperformed.
Maybe It’s Just This Simple?
With all the crosscurrents weighing on the economy and financial markets, it is easy to get lost in the weeds attempting to figure out what the stock market may do in the coming year. Will Omicron force another economic shutdown, bringing a serious market decline? Will inflation prove the Fed is correct in retiring its “transitory” tag, forcing monetary officials to speed up tapering and perhaps raise rates sooner than expected? Will high valuations finally catch up with Tech stocks?
Some Inflation Reassurance
Headline inflation reports, including the Consumer Price Index and wages, continue to run disturbingly hot! As a result, investors worry that ongoing inflation pressures will eventually contract equity valuations, push bond yields higher, and force the Federal Reserve to act much sooner and more aggressively than planned.
2022 Cyclical Tilt?
Even though cyclical stocks’ excess return has been somewhat modest in 2021, they have done well overall since the start of this bull market. Moreover, while the economy is poised to slow next year, real-GDP growth should post another healthy gain near 4% to 4.5%—helping to keep cyclical stocks in a leadership position. Thus, owning a wide variety of cyclical stocks again during 2022 probably makes sense. Still, there are a couple of reasons investors should consider tilting those cyclical bets toward consumer cyclicals rather than industrial cyclicals.
Bonds Are BAD!
Why do we own bonds? I understand the nostalgia. After all, bonds have been part of portfolios ever since, well, there have been portfolios. They have always represented the consummate balancing asset; bonds make those risky stocks tolerable and allow a restful night’s sleep. But, just like Linus and his blankie, it’s tough to let go of such a comforting friend.
Labor-Market Runway?
The U.S. labor market holds the key to the duration of the economic expansion and its corollary bull market. In October, the U.S. unemployment rate declined to 4.6%—which is lower than 75% of the time since 1948. Although there’s still room for further improvement, historically, when the unemployment rate fell below 4%, economic conditions often became difficult.
Monday Musings
Just cleaning out the “thought box” today…
Cyclicals Are CHEAP And UNDER-OWNED
In this prolonged era of growth-stock dominance, cyclical stocks seem antiquated and passé. Why own something that is highly volatile, subject to the vagaries of an unpredictable economy, and offers no true sustainable long-term growth story? Particularly when there are FANGS available that are painting the future of society and the economy. FANG-style stocks are also much steadier, significantly less connected with economic cyclicality, and offer sexy future growth. When I put it that way, I too am having a hard time being convinced to buy a cyclical stock?
Inflation & Yields: Some Historical Observations
Investors have two primary questions regarding the current inflation problem: 1) Is the recent inflation surge just temporary or will it prove sustainable, and 2) Why are bond yields ignoring higher inflation? Unfortunately, we do not have a definitive answer for either question, but a look at U.S. history is informative.