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Dear Clients & Friends,

I think we’re all thinking it; so long 2020 you won’t be missed! However, if the first week of 2021 is an omen of what’s the come this year, I’d prefer to unsubscribe. Q4 was generally speaking a very positive quarter, especially in light of the year most have had and the impacts from COVID on all of us. To the pulse of the collective, the vaccines feel like a light at the end of a dark tunnel. The US presidential election went smoother than most predicted although some were surprised at how split we appear to be as a country.  Most folks I have spoken with believed Biden was going to have a decisive win and our country would be less divided.  For now, those dreams will have to remain a dream.   United States of America no longer suits us and possibly hasn’t for a while.  The States of America feels more apropos.  In a very telegraphed manner however, the (current) president filed various lawsuits claiming widespread voter fraud, and recently it was discussed he pandered to the GA officials to “find him votes”.  Prior to the election, the market concern was that a Democratic sweep would raise taxes and hurt economic growth at a key point in our recovery.  We are going to find out very soon which way the Georgia run-off will go, but as of the time of my writing, it appears Democrats will succeed.

As I highlighted a few months ago, I think the central banks are stuck having to perpetually intervene when trouble arises in the markets and the economy.  It started with the “Greenspan put” and has evolved into the global central bank put. I think it is more palatable to support markets than it is to do nothing at this point since we’ve built up too much financial leverage that the unwind would be very ugly.  Therefore, it’s conceivable we will experience broad market increases with intermittent volatility (brought on by recessions, pandemics and other events) matched with central bank intervention.  If you think about, there hasn’t been a bear market since 2009 that the Fed hasn’t stepped in.  While the Fed didn’t inject liquidity in late 2018 when markets fell almost 20%, Powell did speak dovishly and subsequently lowered rates.  So while the Fed is supposed to maximize employment and maintain stable prices, it likely believes it can achieve this mission via the stock market and financial assets.  The obvious downside is that the more you prop it up the system like we’ve done, it creates scenarios where smaller shocks have larger consequences than they otherwise would have.  And then the system requires more capital injections, reinforcing the cycle further.  This is often referred to as a positive feedback loop.

So in summary, I think markets will keep going up until they don’t at which point the Fed will print and throw money at the markets through various means pushing back up financial assets until the next hole bursts in the dyke and the cycle repeats.  With another round of stimulus approved, this could further buoy markets in the short term.

Now onto everyone’s favorite topic, valuations…

Let’s have a brief look at what is driving the return for 2020.  Anyone want to guess what’s NOT contributing to returns?  If you guessed profits you get a cookie.  All of this year’s return can be labeled as multiple expansion.  That means on average, the S&P companies lost money this year but their prices went up as did the market’s valuation.
Some say this rally doesn’t have any teeth. Take a look at these FANGs.
The big have gotten bigger with this market rally. As more and more investors turn to passive investment vehicles, they have to buy the largest companies in the index creating a positive feedback loop.
It’s not just a handful of expensive stocks driving valuations to such an extreme; the median S&P 500 component is now more than 50% more expensive than it was 20 years ago.
 In nominal terms, margin debt has risen to a level more than double its peak from 20 years ago. Even relative to the size of the economy, leveraged speculation recently spiked to a new record high. What’s more, this doesn’t even incorporate leveraged ETFs or options trading which have also risen to new records in terms of popularity and use. 
The S&P has risen substantially while corporate profits after tax has declined markedly. This has pushed valuation metrics to extremes.
If you look at the S&P to operating earnings, we have hit dot-com levels.
The price to sales ratio in the S&P has also meaningfully surpassed dot-com levels.
In fact, if you look at most metrics, we are at or near the 100% percentile and setting records each successive month that the markets march higher while profits and sales lag.
If we look at a poll that was recently conducted by Bloomberg by 17 institutions, the average respondent believes the S&P will end 2021 around 4,000. That would represent a 6.6% gain for the year and result in the 2021 PE ratio being around 23.
Analysts are an optimistic bunch. Aside from 2 or 3 years going back to 1979, analysts were optimistic relative to their expectations of the S&P earnings. If you assume this still holds true today, the forward PE ratios that are expected in 2021 and 2022 could go even higher into over-valued territory. If history is a guide, the PE ratio you pay when you’re passive has predictive power over future returns. The lower the PE ratio the better for future returns.
As we see from the previous charts, the expected earnings might prove optimistic and the actual PE ratio could be much higher.
Bloomberg Dollar Spot Index
The dollar has been very weak after a surge in the early days of COVID. With the Fed hitting copy and paste and printing USD, we could see the dollar fall further in 2021. I don’t believe we’re at risk of losing the reserve status anytime soon though.
This chart is outdated as of the time I am writing this since Tesla’s market cap has exceeded $800 billion. Tesla is the poster child for market froth that many point to.
Speaking of things that don’t make sense to lot of people, Bitcoin has surged over the past year from a low of under $4,000 during the pandemic to over $40,000 recently. I find people are divided on this asset as well with some calling for prices as high as $400,000 or on the other side a fraud.
Mortgage rates continue to fall as rates stay low. Housing prices in the suburbs have really turbo charged in recent months.
Rising prices, as we see in the housing market right now, result from some combination
of higher demand and lower supply. It’s not always clear which is more important. This
chart shows far fewer single-family homes are for sale as we start 2021 than in the last
several years. This dynamic is pushing up prices across the country, except for dense cities such as NYC and SF.

Economically, the pandemic’s prime victims were retailers and service businesses like restaurants and hotels. Those industries are suffering and many firms have already failed. But the damage doesn’t end there. Most of those businesses have landlords who are not getting paid. You can see the result in this graph of delinquency rates for commercial mortgage backed securities (CMBS). Of course “delinquency” doesn’t necessarily mean default, though it can lead there. The just-passed relief bill may help some small businesses pay rent a few more months. But beyond that, the prospects look bleak. And that’s before we even know what permanent behavioral changes all this will bring.
COVID hospitalizations are still on the rise. Vaccine rollouts needs to happen at a faster pace so we can all get back to the way it used to be.
Hopefully this expected vaccination timeline holds true. Perhaps the incoming administration can speed this up.

And if you happen to find yourself in a Delorean with a flux capacitor, remember to never visit 2020!

I hope you enjoyed this quarters financial markets update.  If you have any questions please contact us directly.  If you’re interested in a topic that you’d like us to address, please email us so we can include them in future updates.

If you’re interested in starting a dialogue and learning how we can help, please contact us.

Best Regards,

Jared Toren
CEO & Founder

Sources: Edges & Odds, WSJ Daily Shot, 361 CapitalSteve Blumenthal’s On My Radar

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Author: Jared Toren

Jared Toren is CEO and Founder at Proper Wealth Management. Proper was born out of frustration with the inherent conflicts of interest at big brokerage firms influencing advisors to sell products that were not suitable for clients but profitable to the firm along with a consistently mixed message of who’s interest was supposed to be put first; the clients’, the firms’, shareholders or advisors. At Proper, our clients interests come first. We are compensated the same regardless of which investments we utilize so there’s no incentive for us to sell high commission products. Since we focus on a small number of clients, we are able to truly tailor our advice to each person’s unique circumstances.
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