February 8, 2021

With the S&P 500 breaking 3,900 today, let's take a look at valuation.

First, when we entered earnings season, the expectation was for another deep decline in year-over-year earnings. 

Given that Q4 2019 registered a near record high on quarterly earnings for S&P 500 companies, the idea of beating such a number in Q4 2020 (in the midst of a Pandemic and a government throttled economy) wasn't even on Wall Street's radar. 

But we might get it. 

With about 85% of companies now reported, about 8 out of 10 have beat on estimates, and the change in earnings compared to Q4 of 2019 is now projecting a +3.6% growth.  That compares to what was expected to be a 9.3% contraction.

With that, if we look at the earnings projections for full year 2021, the forward P/E on stocks (the S&P 500) comes in around 22.  

That's well above the long run average P/E (ttm), which comes in around 16. 

But, we're not just in a low rate environment, we are in the extreme of all low rate environments — zero rates.  And historically, when the 10-year is below 3%, stocks tend to trade at a P/E north of 20.  Why? The low rate environment does what is intended to do, force people "out on the risk curve" (i.e. force them to accept additional risk in pursuit of higher required returns).  That means, out of bonds, and into stocks (which drives higher multiples).   

So, a forward P/E of 22 could still be cheap in this rate environment, especially with the Fed's aggressive QE program/stance.

But I suspect this multiple will become cheaper and cheaper, as we begin to step through 2021 earnings.   The full-year estimate for this year is looking for 23% earnings growth.  That number may be crushed. 

Remember, these companies will be reporting against a very, very low earnings base, especially from the first half of 2020.  As we know, corporate America always takes the opportunity to put all of the bad news on the table in a widespread crisis.  It's safe to say that any loss or writedown they could take, they took last year (when things were broadly very bad and uncertain).  That sets up for big growth in y-o-y earnings for 2021 – even bigger than Wall Street's full year estimate of 23% growth.  And a higher "E" in the P/E, drives down the valuation on the broad stock market.  

Bottom line:  Even at a forward P/E of 22, in this (global) rate environment, stocks may still be relatively cheap.  And it's likely that valuation will be getting cheaper, especially with more stimulus dollars coming down the pike to stoke economic growth.    

February 5, 2021

Yesterday we talked about China’s buying spree in commodities, repeating their post Global Financial Crisis strategy of building inventory in the world’s most important commodities, at cheap prices.

With that, oil prices have the perfect storm.  The new administration has vowed to kill the U.S. fossil fuels industry.  The global climate actioners have coordinated to choke off capital to new oil exploration projects (globally).  And China is buying oil around the globe at the fastest pace on record. 

This is a recipe for lower supply.  And demand is only growing, as the economic recovery picks up, despite the idea that we will all drive electic cars one day (it won’t be anytime soon).  Lower supply and higher demand means oil prices could move much higher, fast. 

This creates two problems:  1) higher energy prices will weigh on the economic recovery, and 2) higher energy prices will feed into the inflation data, which will force the Fed (and global central bankers) to get to work on reversing the ultra easy interest rate environment — which will then weigh on economic recovery.

Here’s a look at the chart of oil as we end the week.  

February 4, 2021

Biden made his first prepared foreign policy speech this afternoon.

Remember, the Trump administration spent the better part of four years fighting China's ascent to global economic superpower.  Trump waged the trade war with China, ultimately getting concessions through a "Phase 1" deal.  A month later, a global pandemic orginated from China.  And by mid-summer, Pompeo explicitly declared the Chinese Communist Party "the greatest threat to everyone in the free world." 

So, what did the new President have to say about China today in his first historic foreign policy speech?  Almost nothing. He positioned China as a cut-throat economic competitor.  Russia is the threat to democracy as it's told by the new adminstration. 

With that, as we've discussed in my daily notes, the CCP is the big winner in the American election.  China's leadership gets to go back to the business that got them so close (pre-Trump) to becoming the global economic superpower — ramping up the global supply chain and manipulating the currency to ensure they maintain global dominance in exporting. 

But, while they have been in a position of strength economically, relative to the rest of the world, over the past 12-months, China has focused on importing.  They've been stockpiling global commodities at dirt cheap prices, just as they did in the aftermath of the Global Financial Crisis.

China bought record volumes of crude oil, copper, iron ore and coal in 2020.  They also imported a record amount of corn, wheat and soybeans. 

So, that's record levels of industrial metals, energy and food.

What happened to commodity prices the last time China went on a commodities binge in a global recession (a decade ago)?  Prices spiked. 

Oil went from the low $30s back to north of $100, all while the U.S. economy was still suffering. 

Copper prices went crazy. 

With the above in mind, crude oil traded above $56 today, the highest levels since last January.  And broad commodities are in the very early stages of a new bull market.  

Expect China to continue to take advantage of the opportunity to build inventory in commodities.  With that, and with the "inflating global asset price” theme we've been discussing, these prices have a long way to go (up).   

February 3, 2021

As we discussed on Monday, an "impartial" team of experts (the Congressional Budget Office) tasked with helping Congress make informed decisions, thinks the economy will be pretty hot this year, with no concerns about inflation. 

And this is before any Biden policies, before any additional aid, and before any massive multi-trillion dollar clean energy economic transformation spend.

We had more support for this CBO projection today. 

 
This chart below gauges economic activity in the services sector.  Not only is it a V-shaped recovery, but activity has returned to early 2019 levels. 

Now, services is the segment of the economy that is thought to be destroyed from the virus restrictions. 

Some areas of the services sector have been (hotels and food services), but in large part, despite the perception, the services economy has boomed since April.  Real estate has been the hottest, followed by (in order of strength) construction, wholesale trade, finance and insurance, transportation and warehousing, health care, management and support services, agriculture, forestry, and fishing and hunting. 

Also in the January report from the Institute of Supply Management (ISM), the survey details prices paid.  Prices paid by service organization for materials and services are running hot

Commodity prices that were more expensive in the month of January?  All of them.  Commodity prices that were cheaper?  None. 

So, prices are up, inventories are down.  That means inventories will be rebuilt at higher prices. 

With all of this activity, employment in the services sector is expanding at pre-pandemic rate in January.   

Again, this all confirms a good economy (and getting hot).  And it's thanks to the fast and aggressive response from the Fed and from the Trump administration within two weeks of the economic shutdown, back in March of last year.  That kept the economy alive and has proven to be a more than sufficient bridge to a vaccine. With that, we're not just on path to return to pre-pandemic growth levels, we're on path to exceed that, and exceed long-term trend growth this year (maybe by a lot). 

As I asked on Monday, why would Congress approve another $1.9 trillion in "aid?"

If we consider what prices are already doing, pouring another $1.9 trillion on a what is already projected to be a hot economy (and maybe even more money behind that, to fund the clean energy plan), Congress is setting us up for some very ugly inflation.  

February 2, 2021

Amazon reported today after the bell.  They crushed estimates, with record quarterly earnings and record quarterly revenue.

If we annualized the numbers from Q4, it would bring the P/E down to 59 (from 98), and the $1.7 trillion market value would value the company at 3.4 times sales.  Not surprisingly, sounds expensive. 

Now, Amazon has a duopoly in cloud computing, with Microsoft.  And with that dominance in the highly profitable cloud business, as you can see in the chart below, the trajectory of the stocks look nearly identical. 

How does the AMZN valuation stack up to the valuation on MSFT? 

If we annualize the most recent quarter numbers on Microsoft, we get a stock that trades at, a far cheaper, 29 times earnings.  But it trades 11 times the annual run rate on revenue.

As we know, Amazon has a very diverse business, and the cloud has historically funded losses in its more disruptive businesses (like retail).

But if we step back and just look at earnings, Microsoft produces more than twice as much net income as Amazon.  If you had to pick one to buy and one to sell (short), it's always been a bad bet, to bet against Amazon.  But with Jeff Bezos stepping down as CEO today, and moving to the Executive Chairman role, maybe that makes the decision easier — to favor Microsoft.   
 

February 1, 2021

The Congressional Budget Office (CBO) published its Economic Outlook this morning.

Now, the CBO is said to be an "objective, impartial, and nonpartisan" group of experts with a mission of helping Congress make effective budget and economic policy. 

Okay, with that, the CBO has projected that the U.S. economy will fully recover to new highs in economic output by the middle of this year, growing at an estimated 3.7% annualized rate.  They also project that unemployment will fall to 5.3% this year, and inflation will remain a very soft 1.5%.

Let's take a look at those numbers with some historical context …

The above chart is 50 years of quarterly year-over-year change in U.S GDP (annualized).  This line of regression (yellow line) is slighly downward sloping and comes in just under 2%.  That happens to be about where economists have been saying, for years, is the "new normal" growth rate.  This year, the projection from the CBO is for 3.7% growth. 
 
With this in mind, we know that the fiscal and monetary response has been far bigger than the damage to economic output. The economy contracted by $2.2 trillion in 2020, from Q1 through Q2.  And the response has been $3 trillion from the Fed (in balance sheet expansion) plus $2.7 trillion in fiscal stimulus from the federal government.  The response has been greater than the damage.   

Not surprisingly, as a result, we're getting hotter than normal growth in the recovery. 

And not surprisingly, the jobs market has made huge gains. 
  
On that note, here's a look at the projected unemployment rate …

As you can see, if we draw a line of regression (yellow line) over the past 35 years of monthly unemployment data, the CBO projected unemployment rate for 2021 comes in lower.

What about inflation? 

Despite projections of hot growth and continued improvement in jobs, and despite the deluge of liquidity already deployed through fiscal and monetary policy, the CBO projects the same subdued inflation we've had for decades now.

Now, this is very important:  These projections from the CBO assume that current laws on taxes and spending remain in place (as of January 12), and that no significant additional emergency funding or aid is provided.  

So, to recap, this "impartial" team of experts tasked with helping Congress make informed decisions, thinks the economy will be pretty hot this year, with no concerns about inflation.  And this is before any Biden policies, before any additional aid, and before any massive multi-trillion dollar clean energy economic transformation spend.

One might ask, why would Congress approve another $1.9 trillion in "aid?"  '

They shouldn't. 

But with aligned leadership in the White House and Congress, they will.

 
This should make us all very concerned about the inflationary consequences.  

January 29, 2021

Stocks are down, yields are up today.  That's not a great combination – the selling of stocks and the selling of bonds.  

Is there concern about market stability, given the events of the past few days (the short squeeze)?  Yes.    

Anytime you have an improbable event happen in markets (like a short squeeze that takes a stock from $42 to $483 in five days), there is likely some damage that comes with it.  If counterparties (brokers and banks) were to begin fearing the creditworthiness of other counterparties you can quickly get destabilization across markets.  Long Term Capital Management comes to mind. 

LTCM required a $3.6 billion bailout coordinated by the Fed.  Yesterday, within hours Robinhood raised a billion dollars.  That's the difference of two decades.  It's the difference between a Silicon Valley darling and a stealth Connecticut hedge fund.  And it's the difference between the global liquidity environment of today, and 23 years ago.  

To be sure, it's an unstable country, and an unstable world. 

But remember, there were global crises in the late 90s (Asian Crisis, Russian Default, the blow up of LTCM), and yet it was a boom period for the economy and for stocks.  There were plenty of shock risks coming out of the depths of the financial crisis (near debt defaults in Europe, U.S. debt ceiling sagas, government shutdowns, Russia's invasion into Ukraine, nuclear threats from North Korea, the Ebola scare) … and yet the broad stock market tripled in five years

The shared feature in those cases: Intervention (or the threat of intervention). 

We've had plenty of intervention over the past year.  And we will have more, if needed, by central banks and governments to maintain stability. 

 

For stocks, liquidity is king.  And there is a tsunami of liquidity from global policymakers.  And, as importantly, central banks stand ready to act, to absorb any potential shocks to confidence. The Fed is on red alert.  The trajectory of asset prices will continue – up.
 

January 28, 2021

The focus of the financial media over the past few days has been on the massive squeeze of the most heavily shorted stocks in the market. 

What happened today?  

The brokers stepped in to stop the insanity, putting restrictions on some of these stocks that had become targets for indiscriminate mob buying.  We'll see if there's any wounds in the brokerage industry, resulting from losses.  It's reported late this afternoon that Robinhood is drawing on credit lines.    

For the broader market, the action of the past few days may have cleared the shorts from many heavily shorted/short-seller targeted stocks, for a while.  As we discussed yesterday, in a world where asset prices are being explicity inflated by monetary and fiscal policy, this is not the environment to be betting against the nominal price of assets. 

With that, some of these stocks (definitely not all), have been unduly weighed down for years by short sellers (they've been targets).  This shake out creates opportunities for investors to start picking through some of these names for value opportunities, in a market where valuations have been running hot. 

If we look through a screen of $10 billion+ market cap stocks, with greater than 20% short interest, we have fourteen names.  If we take it down to $2 billion+ market cap, we find a lot of old-line retailers on the top of the highly shorted and “cheap” list (Big Lots, Michaels, Dick's, Camping World).

January 27, 2021

Let's take a look at the chart of the stock everyone has been talking about the past few days.

It's Gamestop …

Fourteen days ago this was a $20 stock.  Today it traded as high as $380. 

This was a heavily shorted stock.  And in a world where governments and central banks (particularly in the United States) have explicitly trashed the value of money, which is repricing everything (in nominal terms), you don't want to own debt, and you don't want to be betting against the nominal price of something (i.e. you don't want to be a short seller of stocks).

Those buying stocks are emboldened by this backdrop.  And that leads to the scenario we are seeing in Gamestop.  The buyers are/have been squeezing the shorts out of their positions.  And that is leading to a hunt for all highly shorted stocks, and short squeezes across the stock market. 

This, I suspect, is a short-term phenomenon.  It's a revaluation of stocks that have been misvalued, and controlled by short sellers (Gamestop, notwithstanding — that one is detached from any reality). 

While this may be a short-term phenomenon, it may all be an early warning symptom of what's coming.  We are seeing ballooning prices in financial assets.  How long until we see ballooning prices of every day products and services in the real economy? 

On that note, it's the Fed's job to manage price stability.  In Jay Powell's press conference today, he said nothing to acknowledge that the Fed was prepared for a such a scenario of runaway prices. 

In fact, he reiterated that they would "wait and see … and not react" to any spike in inflation.  Moreover, he arrogantly explained that the disinflationary dynamics that have held, at least for the past decade, don't easily change.  The Fed expects any spikes in inflation would be short-lived, and that the longer term trend of weak inflation, if not deflationary pressures, would persist.  

With this, we should all expect the Fed to be caught off guard, and in the position of chasing inflation in the near future.  And that would mean hot inflation is coming. 

 
As I’ve said over the past ten months, you don’t want to hold cash in this environment.  You want to be long asset prices. 

January 26, 2021

Microsoft reported earnings after the close today. 

For the eighth consecutive quarter, they beat on earnings and revenues. 

It wasn't too long ago that MSFT was a tech giant that was believed to be past its prime.  If you bought the stock at the top in 1999, you were underwater for 16 years.  If you bought it in 2000 for half price, it was dead money for 13 years (flat line).  In April of 2013, Business Insider wrote a story titled:  "Microsoft Could Be Obsolete By 2017." 

So what changed? 

The same month Business Insider wrote that article, a guy named Jeff Ubben took a $2 billion stake in Microsoft. 

By September Ubben had secured a board seat, and he went to work, pushing for stock buybacks and a new strategy.  He pushed out the CEO, Steve Balmer.  He replaced him with Satya Nadella, who was running the Miscrosoft cloud business.  Nadella's job was to turn Microsoft into a cloud computing company.  He has done it.  

Here's what has happened to the stock …

The stock has now gone up more than 8-fold in seven years.  Today, instead of obsolescence, it's a $1.85 trillion-dollar company, thanks to Ubben.  It's the most extraordinary activist campaign, if not investment and strategic turnaround, of all-time.  

In my Billionaire's Portfolio, we just followed Ubben into his latest high conviction investment this afternoon.  You can join us and get all of the details by subscribing here