Welcome Spring! Last month, when our investment team was discussing the unprecedented stock market recovery since last March, one of our investment committee members referred to the current market environment as a “Cinderella Story” and the metaphor seemed astute, if not somewhat comical.
Just as Cinderella found herself in forsaken circumstances with her two cruel stepsisters and stepmother, so too was the stock market. It was tormented last year by a sudden crash in the oil markets and political uncertainty, both of which were only overshadowed by the mother of all disasters – a global pandemic that led to a mass quarantine state with over 50 million Americans applying for unemployment and over 37% of all small businesses permanently shutting down.(1,2)
Yet, as we all know, every Cinderella has a Prince Charming who can change the situation by promising a royal life full of splendor and endless possibilities. In our case, Prince Charming came in the form of a federal government that was willing to support the economy with over $5 trillion in various stimulus packages. If President Biden’s infrastructure bill passes, that number will rise to $7.25 trillion, which for context is 9x larger than the government’s support for the economy during The Great Financial Crisis in 2008-2009.(3) As a result, the stock market is positioned to perform in a different manner than it has over much of the past decade. Below we have highlighted 5 market themes that we think investors will need to pay attention to over the next year:
Technology (underperform): Household savings are over $1.8 trillion higher than they would otherwise be had there been no stimulus support from the government.(5) These extra funds are starting to be spent by individuals as the world opens back up. As a result, several data points have started to show that there are signs of rising inflation and that higher interest rates may follow. This environment will lead the stocks of growing technology firms to underperform in the near-term since the higher interest rates mean investors can get better returns today rather than investing in companies that hope to generate profits in the future.
Real Estate (outperform): This current economic environment with rising inflation can be very positive for specific real estate companies that are able to continually adjust their rental prices upward. The stocks of companies that operate in the multi-family apartments and industrial warehouses sectors are positioned particularly well since their rental leases are set over shorter timeframes compared to office buildings (which often are locked into multi-year contracts). Additionally, data shows that the new supply of real estate coming onto the market (which would add competition to existing properties) does not appear to be growing rapidly.(4)
Industrials (outperform): The American Society of Civil Engineers gave the country’s infrastructure a C- grade. Approximately 80% of Americans believe that Congress needs to focus on improving our infrastructure.(6,7) While Democrats barely hold a majority, we believe some form of an infrastructure bill will pass since there appears to be bi-partisan support. As a result, material and industrial companies should outperform.
Investment Grade Bonds (focus on short duration): In our last newsletter, we highlighted the fact that bonds would struggle to provide strong returns in the future since rising interest rates lead to falling bond prices (and interest rates have nowhere to go but up right now). This dynamic is amplified for bonds that have long maturities. Over the past year, investment grade companies have taken advantage of the near-zero interest rate environment to refinance their debt at lower rates and with longer maturity dates (much like many individuals did with their home mortgages). As a result, many investment grade bond funds will likely continue falling in value over the next few months as interest rates rise. We recommend specifically focusing on investment grade bonds that are short duration.
Volatility (will persist): One of the negative side effects of the government’s stimulus support is that many investors have lost any fear of a market pullback and are trading in extreme ways to try to realize a quick profit. This is one reason why we have seen companies that have enormous amounts of debt and fail to generate a profit outperforming many higher-quality stocks. It is also why we have seen massive stock swings not only in the stock prices of smaller companies like GameStop but also in more established names. For example, over 5 business days, Apple’s stock value increased by $265 billion (more than the entire value of Coca-Cola as a company).(8)
The interesting aspect of where we stand today is that we must recognize that there will be a third part to our Cinderella story which continues after the traditional tale ends. This third phase represents the time when the excitement dies down and normal life resumes. For us that will occur when the federal government begins to slow down the level of its support and the forces that had been driving the stock market pre-pandemic take effect once again. For example, inflation may rise in the near-term but ultimately nothing about the government’s intervention has changed the fact that we have an aging population and shrinking workforce which will lead to lower inflation and lower interest rates as it has for the past 30 years. In this environment, technologically enabled firms will become attractive once again.
Entering the Spring season, our goal is to continue to focus on long-term trends that will have a positive impact on our portfolios. As always, if you have any questions or would like to discuss your investment strategy in more detail, please do not hesitate to reach out.
Wishing you and your family a warm and happy Spring season,
The Michel Team
Susan, Carol Ann, & Rob
1) Forbes “Nearly 50 Million Americans Have Filed For Unemployment—Here’s What’s Really Happening” 2) Opportunity Insights Economic Tracker, Womply 3) Apollo Chief Economist “Fiscal Response to Covid” 4) Blackstone Research “Duration will be Central to this Historical Recovery” 5) Barron’s “Americans Are Sitting On Lots of Spare Cash. It May Not Boost Growth Much 6) ASCE “2021 Report Card For America’s Infrastructure” 7) Politico “American’s Priorities For the New Congress In 2019” 8) Wall Street Journal “White-Hot Stock Rally Masks Mammoth Value Swings"
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC, and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation, or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.