Pfizer’s (NYSE:PFE) announcement that its vaccine was over 90% effective was quite a welcome relief! It gives us confidence that we will get our arms around the virus soon. Quite an accomplishment!
Unfortunately, we will first experience a massive increase in cases/deaths as we move through the winter, which will force additional shutdowns slowing the economy down. Notwithstanding, we see enough momentum and enough liquidity along with additional stimulus that will carry us to the other side (springtime) when we expect a sharp acceleration in growth both here and abroad that will last several years. We need to deal with the surge over the next few months, acknowledging, as investors, the difference between Main Street and Wall Street. We would take advantage of any market weakness over the winter to add more economic sensitivity to our portfolios as we see growth and earnings well above consensus in 2021 and 2022 supported by a Fed that will keep rates low for years, permitting the economy to run hot.
As Dr. Fauci said yesterday, “COVID won’t be a pandemic for a lot longer,” thanks to rapid progress in vaccine development. He also expects to hear that Moderna’s (NASDAQ:MRNA) vaccine is as efficacious as Pfizer’s vaccine within a week. Vaccines are the key to getting our arms around the virus. In contrast, better therapeutics such as Lilly’s (NYSE:LLY) antibody monoclonal cocktail significantly reduce hospital time and the death rates meaningfully. We expect to see several one dose vaccines viable at room temperature, available for all by next summer. There is light at the end of the tunnel.
While our economy has recovered significantly since troughing late last spring, we are still running wildly below past levels. We expect that gap to be filled and exceeded over the next 18 months. Unfortunately, we are not as optimistic about fully recovering jobs lost due to the pandemic as corporations have learned to do more with less. On the positive side, we expect large productivity gains, which will feed into much higher operating margins and profits. Goldman Sachs (NYSE:GS) seems to concur with our view raising its forecast last Thursday for economic growth, profits, and levels of stock prices well above consensus for 2021 and 2022. Its objective for the market is 4,300 by 2021 and 4,600 by 2022 vs. 3,564 today. GS expects the Fed to remain on hold for five years. Really! We are not there as we see a meaningful pickup in inflation in 2022, which may cause a shift in Fed policy sometimes in 2023. But there is a lot of room to run before that.
The market pundits continue to focus on day to day rather than looking out over the next 6, 12, and 18 months as investors. It will be a tough winter for sure. There will be a surge in cases and deaths. There will be partial shutdowns, but nothing like last spring. But we can now see the light at the end of the tunnel. Biden has won the election, and we fully expect his first act as President will be a huge stimulus bill to help individuals, small-/mid-sized businesses, and states make it to the other side. Also, he may introduce a bill mandating masks and social distancing rather than leaving it to states. He will work on a plan to distribute vaccines. Finally, we expect him to mend fences with our major trading partners going so far as to suggest a coalition to moderate China’s ambitions. We will not know until the runoff in Georgia is completed in January whether the Republicans have a majority in the Senate. We hope to prevent ill-conceived tax changes that would hurt growth, employment, and investment. We are not against higher income taxes and closing loopholes on the wealthy if all given to the lower/middle classes as that shift would boost growth due to differences in propensity to spend.
You have to ask yourself, are you a trader, or are you an investor? Are you focused on the next few days and months or 6, 12, even 18 months ahead? We are investors.
Our economy has a lot of momentum today, as evidenced by strength in retail sales, housing, automobiles, and manufacturing. Initial unemployment trends have continued to move down, too, with claims falling to six-month lows of 709,000 and continuing claims declining to 6.79 million. If there is any real economic weakness, we would expect it in the first quarter. However, we would also expect a massive stimulus plan to offset it, which investors will focus on rather than the weakness.
Powell commented at an ECB panel that displaced workers will need not only extended benefits but also our future economy will be different more leveraged to technology, making it even more difficult for many workers. Hence, future unemployment may be higher than previously assumed during a recovery; therefore, policymakers will have to stay more accommodative than normal. We agree, which is positive for risk assets.
There is light at the end of the tunnel. The pandemic has caused economic weakness here and abroad, and we are getting our arms around it sooner than most ever believed possible. Again, ask yourself a few simple questions. Do you expect cases to subside as the weather warms? Do you expect the opening to accelerate? Do you expect additional stimulus bills? Do you believe that there is enormous pent-up demand? Do you expect vaccines to be distributed for all by the summer? Do you expect the Fed to stay overly accommodative? An acceleration in economic growth here and abroad is in the cards beginning in the spring. We expect positive operating leverage, large productivity gains, and significant margin expansion leading to surprisingly strong earnings and cash flow.
Our base case is that S&P earnings will increase to $160/share in 2021 and $185/share in 2022 vs. $125/share in 2020 as revenues and margins improve sequentially over the next two years. The market is selling at 22 and 19 times expected annual earnings, which we find attractive with rates so low. Goldman agrees.
Proper stock selection is always the key to outperformance. Over the last six weeks, we have been shifting our portfolio allocation favoring companies with significant operating leverage that will benefit from a global economic recovery that we expect beginning as the weather warms and the number of cases ebbs. Each company has excellent management, winning short-/long-term strategies, dominant market positions, and strong financials. Areas of emphasis include global industrials, commodities (x-oil), transportation (x-airlines), and several unique situations. We reduced our exposure to technology to a market weighting emphasizing software, digitalization, the cloud, 5G, and new normal beneficiaries.
An investor must look beyond the near-term risk of an acceleration in cases/deaths, knowing we have at least one effective vaccine which will be distributed throughout the United States by the summer. Take advantage of any weakness over the winter as traders focus on the near term rather than the long game. There is an incredible $4.8 trillion in money market funds; over $40 trillion in bond funds vs. $30 trillion in stock funds; a savings rate over 14.2%; $16 trillion in bank deposits; home prices/wealth at all-time highs; and an accommodative Fed for years to come. There is an immense amount of excess liquidity in the system that supports the economy and will find its way into equities as the economy improves and individuals/institutions gain more confidence. And trillions of added stimuli are on the horizon.
We see the potential of an overheating economy and a blow-off in the equity markets as we get to the other side as investors are still over-weighted bonds and underweighted equities.
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Remember to review all the facts; pause, reflect, and consider mindset shifts; look at your asset mix with risk controls; turn off CNBC, do independent research, and…
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.