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Synopsis: “A Brighter Future” – Episode 37
In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the growing likelihood of a stock market correction, the pillars supporting further stock market advances and whether they are intact, the volatile rise of Bitcoin as an alternative asset, and the prospects for “Work From Anywhere” (“WFA”) continuing.
The topics discussed in this episode are: How extended is the current market advance?, How robust are its underpinnings and have they been in any way compromised by recent events?, Is it possible to make a long-term case for owning Bitcoin?, and What are the likelihood and investment implications from “WFA” continuing?
Please tune in for more timely insights.
Hello and welcome to our first episode of “A Brighter Future” for 2021. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and back for our second season is David Garrity, Chief Market Strategist for Laidlaw & Co.
David, I hope you had a nice, and of course socially distanced, holiday season.
Rick, the holiday break was enjoyable, thank you, but not without its challenges. I rented a house in northern New Hampshire, thinking that being in The North Country with the snow would be a good way to be socially distanced with the opportunity to get some skiing in. Two things happened. First, the rainstorm that swept the East Coast on Christmas Day washed away the snow cover. Second, I didn’t count on the plumbing in the house’s one bathroom clogging on New Year’s Day, so the household had to head back home that night, driving through a blizzard. We made it back safely, but clearly it made for some unsought-for holiday excitement. As I said to the plumber who came late on New Year’s Day, but failed to clear the clog, “2021: new year, same stuff.”
David, to say 2021 has started off with a bang is bit of an understatement. Equity markets are off to a strong start across the globe, with major indexes hitting fresh record highs last week. Democrats secured the Senate majority following a pair of narrow runoff victories in Georgia. Ten-year yields moved above 1% for the first time in nine months, while small-cap and international stocks outperformed, signaling optimism around the outlook for the post-vaccine phase. Adding to the positive sentiment, WTI oil prices rose above $50, a level last seen in February, as Saudi Arabia announced an unexpected production cut.
Last week also brought some unfortunate, unfamiliar political and social events, but from an investment perspective there were familiar themes: economic data revealed a mix of resiliency and lockdown stress, political uncertainties captured the headlines, and the stock market powered higher.
In a week when the logical market response may have presumably been more negative, the positive gain in stocks is a reminder that the market ultimately takes its direction from fundamentals (the economy, corporate profits, interest rates) and highlights the importance of a long-term view and a disciplined investment strategy aligned to your personal goals, not the news cycle.
So, David, that’s where I would like to start today, having closed the book on a year that contained a global pandemic, a presidential election, a historic recession, an unprecedented bear market followed by an equally unprecedented market rebound, the logical question is what happens next because for example, the market has traditionally done well in the year after a presidential election as well as the year after a recession?
Rick, somehow the phrase, “wild ride,” just doesn’t seem to go far enough in describing 2020 and the early days of 2021. While the stock market’s historical pattern following elections and recessions would offer the prospect of positive returns, something we forecast for 2021 with a “Laidlaw Five” S&P 500 target of 4000, there should be some measure of caution as this market has come quite far, quite fast.
A recent study of 6-month returns for the S&P 500 since 1958 shows only five instances where the market has gained more than +38.0%. On average the S&P 500 over this time period has generated 6-month returns of +4.3% with a standard deviation of +/-11.1%. Based on this, the market’s +45.1% rally at the 6-month mark in September 2020 from the March 2020 low is more than three standard deviations above historical norms and by definition an extraordinary performance. So, what happens next?
Follow-on returns after such performances in the past have been on balance modestly positive (i.e. One Month, +2.3%; Two Months, -0.7%; Three Months, +4.6%; Four Months, +3.4%). In contrast, the current rally (now up +70.9% from the March 2020 low through last Friday’s close) has also broken records in its follow-on performance (i.e. One Month, +4.8%; Two Months, +12.0%; Three Months, +14.1%). On this basis, we have to acknowledge that market performance is extended and possibly vulnerable to disappointment should, for example, 4Q 2020 earnings not substantially exceed expectations as the S&P 500 is trading at 23x 2021 estimates.
That said, we believe a reasonable expectation should be for a -10% correction sometime during 1H 2021. Assuming that the transition to the new administration is peaceful and Congress successfully passes further fiscal stimulus along with there being improved COVID vaccination efforts globally such that economic recovery can unfold, we believe the market will trade higher over the course of 2021, but the ride is likely to be bumpy so best buckle up.
David, last year you discussed the “Four Horseman” of the rally and now we are hearing about the “Five Pillars of the Rally”
- Historic Fed Stimulus
- Historic Fiscal Stimulus
- Vaccine Distribution
- Divided Government
- No Double Dip Recession
Much of the discussion has been as long as they remain in place then the chances of a material decline in stocks that puts the rally in jeopardy is slim. However, one of those pillars, Divided Government, has now collapsed. In looking through history, I found that when a Democratic president took office following a Republican White House, the average stock market return in the following year was +14.1%.
I also discovered that when an election produced the same political party in control of the White House and Congress, the average return the next year was +11.8% and when it was the Democratic party in control, the market returned +13.7%.
So, is the Divided Government theory flawed or have things changed?
Rick, the thought that divided government is beneficial in stock market terms is not a flawed concept as it serves to limit the ability of an administration to implement sweeping policy programs without restraint. The general experience has been that legislative gridlock has been favorable to the stock market.
Now, with last week’s developments, the question is not so much whether the government is divided, but more to the point whether it has been critically destabilized. I believe the stock market has been supported in this moment of political turmoil by the expectation that the Biden Administration will rapidly pursue further fiscal stimulus.
The prospect of this effort proving successful was bolstered as you indicated by the outcome of the recent Senate run-off elections in Georgia that now have the Democratic Party in control of both houses of Congress and The White House. With the margin of majority narrow, bipartisanship will be necessary to pass the related legislation. Whether this proves to be a vain hope in the face of last week’s partisan extremes remains to be seen.
We are at a moment where the integrity of our political institutions is being sorely tested. The law needs to be upheld while at the same time the economy needs to be supported. Government has to be capable of acting in the interest of the people, not the hostage of a political party.
David, let’s look at a completely different topic for a few minutes, crypto currencies and the incredible, almost parabolic move of Bitcoin.
In our “Laidlaw Five” announcement, we said that it was possible inflation could rise over the course of 2021 causing Bitcoin to hit $25,000. However, it has now moved through $40,000!!
Is Bitcoin “prone to a sort of correction,” and will it resemble that seen three years ago or will the growing interest in blockchain and cryptocurrencies protect prices from returning to the recent lows?
Rick, with inflation break-evens rising and the U.S. Dollar weakening, investors are looking for various means to hedge against depreciation risk. With negative real interest rates, such traditional inflation hedges as gold should be gaining. However, gold peaked at $2,010/oz in early August 2020 and is off -8% since. Meanwhile, over the same time frame, the cryptocurrencies, specifically Bitcoin, has risen +177% to $31,100. It appears gold has some competition as an inflation and currency hedge as Bitcoin is giving it a run for its money.
There are a number of reasons for this such as it is easier to maintain a digital wallet than a physical vault and transaction settlement is more frictionless with Bitcoin than gold. Viewing it as an alternative asset substitute for gold, various investment firms have issued forecasts that Bitcoin could ultimately reach a valuation level of $146,000 to $400,000. Clearly, animal spirits are likely to remain alive and kicking in the cryptocurrency sector when it comes to considering the possibility of realizing such price objectives.
However, investors should be cautious when it comes to Bitcoin and other cryptocurrencies. There are a limited number of use cases, albeit they are growing as regulatory authorities such as the U.S. Treasury’s Office of the Comptroller of the Currency (“OCC”) have indicated that financial institutions may consider adopting blockchain and stable tokens for use in their operations as a means of increasing transaction integrity and speeding transaction settlement. The investment case for Bitcoin and blockchain more broadly exists, but exposure should be limited at most until further developments show increased regulatory approval and institutional adoption.
David, as bring this week’s episode to an end, let’s shift gears and look at more macro topic – the future of “work from anywhere”
Prior to the COVID pandemic a movement was already brewing within knowledge-work organizations. Personal technology and digital connectivity had advanced so far and so fast that people had begun to ask, “Do we really need to be together, in an office, to do our work?” Well, we got our answer during the pandemic lockdowns as we learned that many of us don’t in fact need to be co-located with colleagues, on-site to do our jobs.
We have seen that individuals, teams, even entire workforces, can perform well while being entirely distributed.
So, now we face new questions:
- Are all-remote or majority-remote organizations the future of knowledge work?
- And is work from anywhere (“WFA”) here to stay?
Rick, we know that changing human behavior can take years, if not generations. However, it has been proven time and again over the course of history that individuals and societies can demonstrate remarkable resilience in the face of adversity and the adaptations necessary to survive and prosper. The COVID pandemic crisis has proven to be such a moment that has forced businesses to shift to a distributed, socially distanced paradigm in order to operate successfully or otherwise face a not insignificant risk of failure.
As we are seeing, containing COVID is not something that is easily achieved. Vaccination efforts are proceeding slowly, the virus is mutating into more virulent strains and there are new outbreaks occurring around the world with last week bringing news of an outbreak in Hebei, China, a city of 11 million people. Guess when it comes to COVID and China, what goes around, comes around. Bottom line, the effort to contain COVID is going to require constant vigilance as the mutations developing are more infectious.
As such, public health policy alone is likely to demand the continuation of WFA. There are myriad implications from this ranging from widening income inequality along the lines of educational achievement as in-person businesses are challenged to a substantial restructuring around the use of and need for commercial buildings over the medium term.
Relative to investment strategy, the persistence of COVID and the semi-permanent adoption of WFA serves to underpin the necessity of an allocation to the Technology sector specifically and towards Growth more broadly as economic recovery prospects are challenged until such time as COVID is brought fully under control.
For now, COVID is outstripping the development and implementation of measures to contain it. That said, investors should keep portfolios balanced as the start of 2021 may prove to be more volatile to the downside.