We have not altered our view that we will have many new and more effective therapeutics distributed shortly to reduce hospital stays and the death rate. There most likely will be at least one vaccine approved by the FDA for emergency use by year-end rolling out into broader use two months later with many more efficacious, simpler delivery vaccines available by mid-year.
The financial markets are laser-focused on current news, including increased cases worldwide as the weather cools, causing some partial shutdowns; Congress’s failure to pass the additional stimulus; and the election. While we all understand and accept that stock markets are supposed to be discounted valuations of future earnings/events, it is not efficient during periods of uncertainty and at inflection points. Stop listening to the pundits daily on cable news who are constantly looking in the rear-view mirror rather than the windshield. You need to be patient. Don’t overreact to the latest news. Let events unfold with an eye to the future and consider all the variables/probabilities. Investing is based on foresight, not today’s new.
Today’s economic problems have been caused by the pandemic rather than any financial stress/issues. Monetary bodies and governments have provided tons of liquidity and stimulus to bridge to the other side. Today, we have trillions of excess liquidity sloshing around the global financial system far in excess of economic needs, which has forced investors further out on the risk curve supporting stock and bond prices. This won’t change over the next 18-plus months even as the global economy recovers as we get our arms around the coronavirus, which is happening now even though the increased outbreaks mask it as the weather cools and more time is spent indoors. The financial system is strong, providing the foundation to fund future growth. Spreads have continued to narrow, which indicates little systemic risk in the system, which is always a concern during turbulent times. Not now!
While cognizant of near-term events, a successful investor must focus on the next 12 to 18 months at a minimum and invest accordingly. Going against the grain is difficult, but you must take advantage of opportunities created short term from those unwilling to look down the road. Investing is based on foresight and lots of patience to let events unfold.
Do you expect the outbreaks to subside by next spring? Do you expect better therapeutics to reduce hospital stays/death rates? Do you see more and more rapid response tests permitting accelerated and safe opening? Do you expect vaccines to be readily available before next summer? Do you expect additional stimulus in the trillions in 2021 and 2022? Do you expect the Fed to remain all in maintaining a near zero-rate policy while buying all bonds insight? Do you see global economies improving by next spring for all the same reasons? Do you see China’s economy continuing to accelerate into 2021?
These are the questions to be asking ourselves. Once we get our arms around the pandemic, which we fully expect will happen by next spring, we project a strong re-acceleration in economic growth both here and abroad, which will extend well into 2022. We do see slower growth in the fourth quarter 2020 and first quarter 2021, down from the torrid pace of 33.1% in the third quarter, but no negative quarters as we fully expect our government, regardless of who wins the election, passing additional stimulus before extended unemployment benefits run out at year-end. In addition, the Fed will do even more if necessary, to provide that bridge to the other side.
The economy has lots of momentum today. Durable goods orders rose for the fifth consecutive month, up 1.9% In September; consumer confidence was 100.9 in October, very strong; home prices accelerated to a 5.7% gain year over year while sales rose 2% month to month; unemployment claims totaled only 751,000 last week, the lowest level since March; personal income increased 0.9% in September while PCE rose a healthy 1.4% leaving the savings rate at a still ridiculous 14.3% and the Chicago business indicator still is over 61.
There is real strength in over 90% of our economy (autos, housing, retail, manufacturing, technology, and transportation) continuing even if additional stimulus is put off a while. However, that is not our base case as regardless of who wins next week, we expect an additional stimulus plan before year-end followed by several trillion more next year focused on increasing jobs. And don’t forget that the Fed will have your backs permitting the economy even to run hot, which we consider a real possibility before the end of next year, especially if global growth picks up like here for the same reasons. Then, China is embarking on a new five-year plan, probably 5-6%/per year, emphasizing the consumer, technology, and a stronger banking system.
News on therapeutics and vaccines continued to be favorable last week, which supports our view that we will get our arms around the virus sometime next spring. In the interim, we heard that Regeneron’s (NASDAQ:REGN) antibody cocktail reduced medical visits by around 57 percent by lowering viral levels and improved symptoms in non-hospitalized patients. This cocktail helps the immune system fight the virus/infections. We also had positive news from Gilead (NASDAQ:GILD), AstraZeneca (NASDAQ:AZN), J&J (NYSE:JNJ), and Lilly (NYSE:LLY). Finally, rapid response tests are rolling out across the country, which supports opening America safely, offsetting some of the surges, causing movements in the opposite direction.
It is hard to believe that the election is next week. Regardless of who wins, we expect several trillion in stimulus programs over the next two years, hopefully beginning with one to extend unemployment benefits beyond December 31st along with monies for small-/medium-size businesses and states. Next year we should see many programs to stimulate growth, investment, and jobs. Biden would outspend Trump, but either way, it will be a big plus for the economy on top of all the excess liquidity in the system along with underlying momentum in many sectors.
We fully expect operating margins and profits to hit new highs next year as corporations continue to tighten costs; leverage technology, not people; and generate vast amounts of cash/free cash flow that will be used to raise dividends, re-initiate buybacks, and make bolt-on acquisitions. While Biden may raise taxes on the wealthy, giving all of it to the lower/middle classes, we do NOT expect him to raise corporate taxes until the economy is well above pre-pandemic levels, which won’t occur until sometime in 2022. Shifting individual tax burdens will boost economic growth in 2021 due to differences in the propensity to spend.
We remain very optimistic that the economic outlook for 2021 and 2022 will be much stronger than generally believed today. We are confident that we will win the battle against the coronavirus; the government will pass many trillions in stimulus plans, and the Fed will have our backs. Strong growth plus rising margins will result in S&P earnings $170+/share in 2021, well above consensus expectations today. The market remains undervalued, selling at less than 20 times next year’s earnings with 10- and 30-year Treasuries offering 0.85% and 1.64% yields, respectively, with bank capital/liquidity ratios at all-time highs.
We are not surprised about the increased volatility and downward pressures in the markets right before the election. The increase in coronavirus cases has hurt too. But a successful investor needs to look down the road at least 12 to 18 months and invest accordingly, like now.
Our base case for 2021 is that we will get our arms around the virus; there will be many trillions in additional stimulus programs; the Fed will remain overly accommodative; the economy will exceed all expectations; global trade will improve; corporate operating margins, profits and cash flow will be at record levels, well above consensus; and the market is 20+% undervalued today.
Next year, the big story will be record operating margins, earnings, cash flow, and returns on capital. The main beneficiaries will be the well-run industrials, commodity (not oil), and transportation companies with tremendous operating leverage as economic growth accelerates. You had to listen to earnings calls to see the huge upside potential out there in these companies that are not seen by the Street. While we still like technology, the sector is not nearly as undervalued or under-owned as these more economically-sensitive investments.
Investing during uncertain times is not easy as you often are going against the grain. You need to have core beliefs, monitor them, do in-depth research, and invest accordingly. Patience is a necessity, along with the foresight to have a vision of where we are going evaluating risk/returns along the way.
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Remember to review all the facts; pause, reflect, and consider mindset shifts; look at your asset mix with risk controls; do independent research and…
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.