As we put 2020 in the rear view mirror, we know it will be a year that goes down in history. The Coronavirus hit America’s shores in March which created a high level of uncertainty. The unknown caused a steep market selloff, which hit a low on March 23rd last year. It was the fastest move from a market high to down 10, 20 and 30%, ever. History has proven that a panicked and emotional market always creates opportunity, so we held course. With hindsight now, the 12-month period from March 31, 2020 to March 31, 2021 turned out to be the best S&P500 performance in the last 30 years. The DJIA & S&P500 are back to all-time highs and the promise of tomorrow is looking brighter.The Government reacted to the economic downturn by adding a tremendous amount of liquidity. Unprecedented amounts of stimulus came to bear and the Fed kept a lid on historically low interest rates. Companies reacted by improving their online experience and, for those that could, working from home became the norm. As a result, the economy has bounced back quickly. We cannot be positive without recognizing that there are still a large amount of American citizens in financial turmoil. The Economic Policy Institute indicated that 82% of the net job losses last year were suffered by the bottom 25% of wage earners. Though the service industry has been decimated by the Coronavirus, the rest of industry was able to adapt.Though some uncertainty lingers; vaccinations, low interest rates, tremendous liquidity, an accommodative Fed policy, and an expected reopening of the economy, keeps us cautiously optimistic. Another positive indicator is the broadening out of the market in terms of industry participation. Narrow market leadership from technology was always a concern. Now we are seeing some rotation from growth to value, which is healthy. Though technology is still up this year, the energy, financial, industrial and basic material sectors are performing better. Broader sector participation is a good sign for the market as a whole.
There are two things that cause worry for some. First, the amount of Government spending could cause inflation and a related rise in interest rates. We believe any short term spike of inflation will be temporary, and though interest rates have accelerated quickly from historically low levels, they remain low enough not to be competitive for stocks. Inflation is not typically bad for the market until it reaches levels that start to curtail economic activity.
Second, valuations are above historical averages. The price of a stock divided by its earnings (P/E Ratio) has averaged around 16 times long term. Though we are at about 22 times earnings now, there are other parameters that may justify it. The P/E ratio being higher is justified in a lower interest rate environment and even more, growth is a primary factor. High growth forecast makes current valuations more reasonable. For example: a stock trading at 30 times earnings may actually be cheap if earnings are growing at 50%. First quarter corporate earnings growth is strong and estimates are rising. At the start of the year, earnings were expected to grow by 15.8% and now, they are estimated at 23.3%. The U.S. economy is forecast to grow at 7%, which is the fastest pace since 1984. Overall, higher growth expectations and low interest rates likely justify the current market valuation.
We believe the reopening of the economy, and historic stimulus efforts, will continue to support the equity market. The road ahead may not be without some potholes, but we remain optimistic intermediate to longer term.
Spring is in the air! Enjoy the season of new growth, and may the hope of tomorrow continue to bloom.