Welcome to the February 2021 Newsletter. This month, we’re discussing the stock market, the economy, the COVID-19 vaccine, and other news.
A technical and fundamental analysis of today’s stock market favors a continuation of a gradual upward trend, although considerable volatility and short-term pullbacks are inevitable given the high valuation levels we have today. The stock market and our economy are heavily dependent on the near-term manufacture, distribution, and inoculation of our families and neighbors.
Until this happens, our economy is showing some signs of flatlining. In the meantime, too many investors are reaching for immediate and unrealistic stock market returns. This is resulting in euphoric speculation. If we can manage an aggressive push to vaccine our population, clearer signs of a strong economic recovery and stock market stabilization should appear.
U.S. nonfarm payroll employment declined in December by 140,000, but the unemployment rate was unchanged at 6.7%. Job losses were most significant in leisure and hospitality with 498,000 job losses in that category. Job gains occurred in professional and business services, retail trade, construction, transportation, and warehousing.
The October payroll number was increased by 44,000 to 654,000. The November payroll number was revised up by 91,000 to 366,000. The rolling three-month payroll average decreased to +293,000 this month from +522,000 last month.
As of December 2020, the unemployment rate by level of education varied considerably.
|Education Level||Unemployment Rate|
|Less than High School Diploma||9.8%|
|High School Graduate, No College||7.8%|
|Some College or Associate’s Degree||6.3%|
|Bachelor’s Degree or Higher||3.8%|
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the advance estimate of the 2020 fourth-quarter GDP increased by 4.0%.
The increase in fourth-quarter GDP reflected 1) the continued economic recovery from the sharp declines earlier in the year and 2) the ongoing impact of the pandemic. It also reflected increases in exports, nonresidential fixed investment, personal consumption expenditures, residential fixed investment, and private inventory investments.
Previously, the U.S. economy shrank 3.5% in 2020. This was the largest GDP decline since 1946 and the first since 2009.
Annual inflation increased to 1.3% in December, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, also increased in December to 1.5% (from 1.4% in November). The Fed’s long-term core PCE target remains at 2%.
Long-term inflation expectations can be determined by measuring the differences between Treasury bond yields & TIPS real yields of the same maturities. Results are:
|Bond Maturities||Annual Inflation Expectations|
This month’s estimated annual inflation numbers above are another 0.17% higher on average than last month’s. Over the previous two months, the above-average inflation is up 0.37%. Over the past four months, the above-average inflation is up 0.52%. That’s significant!
John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Certainly, there are some pockets of euphoria in the market today. But we see continued optimism in the following:
- No one is anticipating the Federal Reserve increasing interest rates or reducing quantitative easing.
- The vaccine distribution continues.
- The next Congressional fiscal stimulus plan is more likely to be on the larger side.
- Fourth-quarter corporate earnings continue to beat expectations.
On the other hand, Mohamed El-Erian spoke February 1 on CNBC and said, “When the cost of borrowing to speculate in the stock market is near zero and Federal Reserve liquidity is abundant and predictive, we will encounter too many people taking on unwarranted leverage, accumulating inappropriate levels of debt and adding excessive stock and bond market risk to their portfolio. These activities, if taken to an extreme, can accelerate our economy to the bottom of the ninth inning, and ‘game over.’”
We should pay attention to four things:
- Has the Federal Reserve performed a U-turn and increased interest rates and or reduced quantitative easing? No, and they’ve said they will give plenty of warning before they do.
- Do we have massive corporate bankruptcies? Not today.
- Have we had a major stock market “accident”? We almost had one last week when the S&P 500 Index lost 2.5% on Wednesday, gained 1% on Thursday, and lost 2% on Friday. As speculation appears to be running amuck, this is unhealthy.
- Has inflation gone up? Average inflation expectations have increased rapidly from 1.64% to 2.16% over the last four months.
The first two items above do not seem to be important right now. But keep your eye on the latter two.”
Stock Market Valuations
We believe the S&P 500 Index companies will have operating earnings of $170 in 2021. With a PE ratio of 21, the Index should have no trouble reaching and maintaining 3570. But the market closed on Friday, January 29 at 3714. Perhaps we are a bit overvalued at this time.
During the latter six months of 2021, investors will look for $190 earning in 2022. With a PE ratio of 21, the market should then be able to reach the 4000s.
Recommended Action for Your Stock Portfolio
Let’s take a look at some long-term facts.
|Average Annual Return|
|2001 – 2020||8.98%|
|2009 – 2020||15.42%|
Keep in mind the timeframe 2001 to 2020 includes the Dotcom bubble of 2001 to 2003, the 9/11 attack in 2001, the financial crisis of 2008-2009, and the pandemic of 2020. Still, the index returned almost 9% per year on average over 20 years. But from 2009 through 2020, the stock market has been spectacular and euphoric! This level of performance will NOT continue.
We can’t predict when the next stock market correction or bear market will begin. But we believe it’s only months away, not years. Most investors have made a lot of money in the stock market in the past 10 years, so now is the time to protect a part of those gains by selling 5 to 10% of your stock market exposure and wait for a better buy-back-in opportunity.
If we’re wrong, then investors who cash out gains now will miss out on stock market returns if the market continues its upward trend without interruption. But it’s riskier to maintain a high stock market position today than to have significant stock market cash reserves now.
Some states are better at distributing the vaccine than others.
North Dakota leads the nation in rapidly distributing the COVID-19 vaccine. They have administered 84% of their supply. North Dakota began planning its vaccine rollout last summer. They chose to distribute vaccine supplies to healthcare providers statewide, not just to hospitals or public health systems.
West Virginia has nearly matched North Dakota with 83% of their vaccine supply distributed. They opted out of the federal plan that put CVS and Walgreens in charge of vaccinating most nursing homes – a plan that is so far proceeding at a turtle’s pace. The state instead is using a network of 250 local and unaffiliated pharmacies – most of which had existing relations with patients. They also enlisted the National Guard to lead on vaccine logistics.
Alaska is successfully using bush planes, snow machines, and dog sleds to distribute vaccines to their remote locations. Which states are lagging in vaccine distribution? California with only 45% and Alabama at 47%.
Below is a summary of vaccine development for five U.S. pharmaceutical companies and one U.K. company.
Pfizer and their German partner, BioNTech SE, have achieved over 95.3% efficacy with their two-shot vaccine during their Phase 3 study of 44,000 volunteers. The second shot is to be taken three weeks after the first shot.
The U.S. originally agreed to purchase 100 million doses of the Pfizer vaccine to be delivered in December through the end of March. In late December, the federal government purchased another 100 million doses, with 70 million to be delivered by the end of June and the remaining 30 million by the end of July. As of January 31, 16.8 million doses of the Pfizer vaccine have been dispensed in the U.S.
Moderna’s two-shot vaccine has shown to be 94.1% effective in preventing COVID-19 during their Phase 3 study of 30,000 volunteers. The second shot is to be taken four weeks after the first shot. In early January, Moderna announced they’re adding staff and buying equipment to produce up to 1 billion doses this year for worldwide distribution.
In mid-January, Moderna announced early lab tests have shown its existing vaccine triggers antibodies to fight the virus variants found in the UK and South Africa. Moderna is testing two 1-shot booster options – one specifically aimed at the South African variant, and another to broadly fight new mutations.
Moderna expects to deliver 100 million doses to the U.S. by the end of March and another 100 million doses by the end of June. As of January 31, 14.2 million doses of the Moderna vaccine have been dispensed in the U.S.
On January 26, President Biden announced the purchase of an additional 100 million vaccine doses from Pfizer and another 100 million doses from Moderna to be delivered this summer. This brings the total to 600 million doses purchased for the U.S. from these two companies, or enough for 2 shots for 300 million people age 16 and up.
Johnson & Johnson has announced their single-dose vaccine has been 66% effective in preventing moderate to severe symptoms of COVID-19 during their 44,000-person Phase 3 trial based on an interim analysis. The efficacy was as high as 72% for those volunteers in the U.S., but it was lower in Latin America and South Africa. The vaccine was 85% effective in all regions in preventing severe COVID-19 symptoms.
The J&J vaccine has the distinct advantage of requiring only one injection and can be safely stored at normal refrigerator temperatures for weeks, making distribution much easier than other approved vaccines. J&J could ask the FDA for emergency use authorization later in February. The U.S. has agreed to purchase 100 million doses of the J&J vaccine if it’s approved by the FDA.
Novavax’s vaccine candidate requires two shots, three weeks apart. The company announced its vaccine candidate has demonstrated an efficacy of 89.3% during its phase 3 trial in the U.K. of 15,000 individuals between the ages of 18 and 84. It’s noteworthy that many of the U.K. individuals were subjected to the new COVID-19 variant that has surfaced within that country.
The Novavax U.S. and Mexico Phase 3 trial has recruited 16,000 volunteers to date and expects to have the targeted 30,000 enrolled by mid-February. The U.S. has agreed to purchase 110 million doses of the Novavax vaccine if it proves to be successful, but no timetable has yet been established.
Merck announced in January it’s discontinuing the development of its COVID-19 vaccines due to inadequate results during early clinical trials. Instead, the company will continue to focus on its experimental therapeutic drugs for people already infected with the virus.
AstraZeneca (a British and Swedish company) has been attempting to manufacture and distribute a COVID-19 vaccine developed by Oxford University. Problems at an AstraZeneca contract manufacturer has led AstraZeneca to tell the EU to expect only 30 million doses of its 2-shot vaccine instead of the 80 million it had previously planned to send during February and March. Also, the EU regulator, the European Medicine Agency, said the AstraZeneca vaccine hasn’t been sufficiently tested in people over 55. Officials say this point of view comes from a lack of data publicly released by AstraZeneca.
The slow rollout in Europe and the prospect of continued lockdowns in much of the region bodes ill for the bloc’s economy. There are no near-term plans for AstraZeneca to apply to the FDA for emergency use authorization in the U.S.
As of January 31, the Daily New Cases chart below shows a peak on January 8, but new cases have dropped off since then. Note the vertical axis increased this month to 400,000 from 300,000 last month.
The Daily Death chart peaked on January 12. We hope and expect it will soon start to drop significantly.
Robinhood: This Month’s Corporate Bad Boy
Source: Page B1, The Wall Street Journal, December 18, 2020
The SEC has fined Robinhood $65 million to settle regulatory claims that it didn’t sufficiently disclose to its customers its business dealings with high-speed trading firms. According to the SEC, Robinhood failed until 2018 to fully reveal on its website how it makes money from client trading. Robinhood, and other retail brokerage firms, generate revenue by routing customer’s buy-and-sell orders to high-speed traders. These traders then kick back a small fee to Robinhood on each trade.
This practice is known as “payment for order flow.” This creates a conflict of interest for Robinhood because of the incentive to send customer buy-and-sell orders to the market maker who pays Robinhood the most per trade, instead of the market maker who will give the fastest execution for the best price. During the first three quarters of 2020, Robinhood collected $466 million in “payment for order flow,” as calculated by Piper Sandler.
Robinhood’s chief legal officer, Dan Gallagher, said, “We recognize the responsibility that comes with having helped millions of investors make their first investments, and we’re committed to continuing to evolve Robinhood as we grow to meet our customer’s needs.”
What is it with bitcoin?
We would love to have a positive attitude toward this new investment vehicle, but it’s not for us or our clients. An important question is, “What is behind bitcoin?”
The answer is, there is nothing behind bitcoin. There are no factories, no real estate, no cash, no stocks, no dividends, no bonds, no gold, no commodities. The only thing behind bitcoin is the faith that current demand will continue. (This reminds us of Tulip Mania during the Dutch Golden Age in 1637. Before the total collapse, some tulip bulbs were trading at 10 times the annual wage of a craftsman.) The lack of anything substantial behind bitcoin is one drawback, but there’s more!
The IRS classifies bitcoin as an asset, not currency. So if you ever plan to buy dinner for your friends at a restaurant that takes bitcoin, if your transaction has a gain, plan on paying capital gains taxes on every purchase you make. What an accounting nightmare!
We recommend investors do not invest in bitcoin. Recently, Kevin O’Leary of Shark Tank said as bitcoin hit $40,000, “I had a diversified portfolio in all the cryptocurrencies. Now with bitcoin at a high, I have just broken even as all the others have tanked.”
Is the bull market in bonds finally over? We think so. See the chart below showing the downward track in interest rates of the 10-year U.S. Treasury Note since 1980. As interest rates decline, existing bond prices increase. Over the past 40 years, increasing bond prices have defined a fantastic bull market for the bond market.
But now interest rates have started to slowly climb as we’re coming out of our current recession. Thus, the price of existing bonds will decline. If this continues, bond mutual fund asset prices will decline as well.
You might think, “I can stand a small decline in my ‘safe money,’ but how much will bond mutual fund prices decline, and what should I do?” See “Recommended Action for Your Bond Portfolio” below.
The Federal Open Market Committee (FOMC) held a two-day meeting on January 26 and 27 and voted unanimously to keep the fed funds rate at the 0 to 0.25% target range. The Fed will also continue quantitative easing by buying $120 billion per month of U.S. Treasuries and agency mortgage securities. The latter will keep long-term interest rates lower than normal.
Janet Yellen was confirmed as the next U.S. Treasury Secretary by a Senate vote of 84-15. She immediately turned her attention toward gaining support for President Biden’s $1.9 trillion fiscal relief package. We are not optimistic this package will pass Congress intact, as a $900 billion stimulus package was just passed in December.
Recommended Action for Your Bond Portfolio
Most bonds are not appropriate today. Our bond market mutual fund list has been reduced to the list below:
- Ultra-short-term U.S. bond funds
- Short-term U.S. bond funds
- Government National Mortgage Association (GNMA) bond funds
The most important thing to remember in selecting a bond fund in this market is to keep the bond fund’s average duration low – under 3 years. The higher the bond fund duration, the faster the fund’s price will decline with rising interest rates. For example, a bond fund with an 8-year duration could easily have its price decline 8% if corresponding interest rates rise only 1%.
At this time, we have no recommendations for these types of investments:
- Bank CDs – interest rates too low
- U.S. Treasury securities – interest rates too low
- Muni bonds – credit risk
- High-yield bonds – stock market risk
- Intermediate-term bonds – duration too high
- Long-term bonds – duration too high
- International bonds – currency risk
- Private and unregistered bonds – always an inappropriate investment
**Please note: Everyone should maintain a safe, liquid emergency fund of at least nine to 12 months of family expenses in an FDIC-insured checking account or money market account before investing in a stock or bond portfolio.**
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.