Inside The Stock Market ...trends, cross-currents, and outlook

It’s certain that today’s cyclical bout of inflation will prove “transitory,” if only because the word itself is practically meaningless. Our time on earth will also prove transitory, and so too will the current stock market mania—to the shock of most of the nearly 20 million “investors” on the Robinhood platform.

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We’ve long considered ourselves lucky to have escaped from our graduate-economics program after only a year. Among the few nuggets we managed to retain was the startling conclusion to a paper written by a famed department professor asking, “Do Large Deficits Produce High Interest Rates?”

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At today’s 30.8x, the Peak P/E stands in the 99th percentile on all time horizons except the “New Era” (1995-to-date). Yet, that’s still five “handles” below the 35.8x all-time high recorded in December 1999. If that figure is matched, the S&P 500 will top 5,000. 

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After the last two months’ violent reversal of the “re-opening” trade, the major indexes for U.S. Large Cap, Small Cap, Growth, and Value all stood with YTD gains in the 14-16% range. Yes, a few nimble portfolio managers might have migrated out of “re-opening” stocks in early April and into the “old” Large Cap Growth leadership but the surest route to superior performance has been to avoid what’s become an almost annual pitfall since the Great Financial Crisis: Foreign stocks. EAFE and MSCI Emerging Markets already trail the S&P 500’s 16.0% YTD gain by about 8% and 12%, respectively.

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This summer marks the first anniversary, not of the COVID-19 stock-market low, itself, but of the much belated “confirmation” of that low.

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While not yet set in stone, it is the consensus view that infrastructure spending will be raised to a higher level for the next few years compared to past baseline expenditures. Although the exact numbers are still unknown, we examined the President Biden-endorsed bipartisan plan to provide a picture of the relative scale of the anticipated spending in the context of historical trends. In addition, we identified a group of industries that may be beneficiaries of the proposal.

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On May 25th, Fed Chair Jerome Powell promised to pull back emergency support “very gradually over time and with great transparency.”

“Very gradually?” No one doubts that. But “with great transparency?” Not a chance...

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The COVID collapse showed the Fed could abandon its clunky forward guidance and make the appropriate “pivot” when the facts changed. Now that facts have changed for the better, the Fed is right back to the rigid and dogmatic approach that characterized Fed-speak for almost all of the last economic expansion.

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Our trusted civil servants must have found a list of our old Economic/Interest Rates/Inflation components and began to “discontinue” those once invaluable to us and other Fed watchers. It’s a hindrance, but we still have the one that is most correlated to stock prices and it’s free: The ever-expanding balance sheet.

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The refusal of the bond market to acknowledge the worsening inflation readings seems to have strengthened the consensus view that any inflation trouble will be “transitory.” Do bonds still know best when there’s a systematic, price-insensitive buyer hoovering up $120 billion of them per month? 

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We expected that the earnings recovery from the shortest-ever U.S. recession would be the fastest on record. Trailing figures for the MSCI USA Index now confirm this: Trailing EPS and Cash Flow Per Share have surged to new highs only 14 months after their March 2020 peaks. 

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On a technical basis, Homebuilding stocks have only just emerged from their decade-long post-bubble bust. With P/B 24% below the mid-2005 peak and 15% below the “overvalued” threshold, they look reasonably priced in a world that’s almost entirely devoid of value.

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In an echo of last decade, the Fed has come under fire for keeping crisis-based monetary policies in place well after a crisis has subsided. Predictably, the Fed rationalizes its uber-accommodation by citing the slowest-to-recover data series from a set of figures that already suffer from an inherent lag (labor market indicators).

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Small Cap median valuations are among the highest in our 40-year database, but they are bottom quintile versus the nose-bleed level of the median Large Cap. If this Small Cap leadership cycle only matches the shortest one on record, it will last another three years. Based on the valuation gap, that guess seems conservative.

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For years, we’ve noted the increasing valuation gap between domestic and foreign stocks. And for years, we contended that the most likely catalyst for a narrowing of that gap would be a recession-induced cyclical bear market in stocks. Evidently the 2020 bear market was not big enough to do the job.

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The ultimate measure of a SPAC sponsor’s success is stock performance post merger: De-SPAC results. We analyze historical returns of De-SPACs that had initial market caps greater than $200 million.

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By our count, the current bull market is the 13th of the postwar period. The 88% gain achieved by the S&P 500 in less than 14 months already places this bull sixth in terms of cumulative gains. We considered it a hindrance that this bull commenced from higher valuation levels than any other in history. Instead, they seem to have provided a head-start. 

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The speculative peak for this market rally may have occurred in either January (when GameStop and other “left for dead” short candidates soared), or February (when indexes tracking the “newborns”—IPOs and SPACs—both peaked). But even if we knew that for certain, a major peak in stock prices could still be months away.

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We don’t make much use of “Forward” EPS for the S&P 500 because analyst forecasts have tended to be hopelessly optimistic. But if their short-term projections are on target, when numbers for the current quarter are reported, 12-month trailing GAAP EPS will exceed the $139.47 pre-COVID peak.

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We understand the various rationale for the upward shift in equity valuations seen over the last quarter century or so. Unfortunately, wiping away all market history prior to 1995 does not make stock valuations appear significantly less inflated. 

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