Thoughts as Markets March Higher

February 16, 2021

Consider these recent data points from Goldman Sachs:

• Shares of companies with negative earnings have outperformed the average stock by 40 percentage points over the last 12 months
• Companies valued at over 20x sales recently accounted for 23% of trading volume and 9% of U.S. equity market capitalization
• Global equities have seen $340 billion of inflows in the last 14 weeks, the largest 14 week inflow on record… and the week of February 3-10 was the largest single week on record
• On February 12, sub-$5 stocks were 56% of share trading volumes vs a 2020 average of 23%

Many are drawing comparisons to 1999 and the tech bubble. There are clearly corners of excess, but there are some key differences to consider. For one, interest rates are much lower now and supportive of higher equity values (the fed funds rate was near 5% in 1999 versus zero now). Secondly, the equity risk premium (spread between the S&P 500® Index earnings yield and interest rates) is actually above historical norms and implies stocks remain attractive. This went negative in 1999, implying no incremental reward for the risk of owning stocks. One important thing to consider, however, is interest rates had plenty of room to decrease back then. Now, just the opposite seems to be the case.

Perhaps this can go on for a while. Indeed, we seem to have the prospect of supportive monetary and fiscal policy as far as the eye can see. We also seem to have the promise of a robust economic/COVID recovery over the next couple of years. In addition, it appears there remain many doubters. Back in ’99, everyone had bought into the mania and seemed carefree. Now financial media is loaded with calls for the bubble to burst. Normally, there’s no bursting until there’s broad complacency.

So what does this all mean? We aren’t throwing cold water on the whole market, but it may not be a bad juncture to exercise a little more caution. While many stocks remain reasonable (especially in the context of low interest rates), there appear to be pockets of excess. The party may continue longer than we expect; however, it could end abruptly in frothier corners of the market. Perhaps it is an okay time to focus a little more on the mundane and a little less on the speculative. Lately it may seem as if downside risk is a thing of bygone eras. But of course it is precisely times like now when we should be even more vigilant of the risk inherent in our markets. As investors, our job is to think about more than just the “reward” side of the risk/reward tradeoff.

IMPORTANT DISCLOSURES
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