Market mutations since the pandemic

plus ça change, plus c’est la même chose — the more things change, the more they stay the same — perhaps a case of natural mutations not metamorphosis

• Markets at all time highs are an outcome of low rates, low taxes, and abundance of liquidity — rates and liquidity are likely to stay put even if corporate tax breaks go away
• Hard to call the top of market/ bubble but pockets of bubble evident, de-SPAC-ed stocks with no revenues remind of tech bubble
• Inflation is spooking everyone but its already in financial assets
• Allocate wisely in quality stocks, now more than ever — be cautious not overcautious

S&P 500 lost $45/sh (<1%) in revenues and $55/sh (~-30%) in operating earnings in a pandemic year of lockdowns, mortalities, and the lack of stratagem to tackle the virus but also the year of fastest ever vaccine development, nonetheless. Fiscal and Fed stimulus of roughly $6 trillion and the promise of a prolonged period of low rates have proved a vaccine of sorts for S&P 500, adding ~$5 trillion to market cap last year and another $2 trillion this year. The virus continues to mutate and we are not out of the woods with new waves in India and lockdowns in Europe, however, the vaccine rollouts have injected hopes of fighting it out and reopening with ~130 mm in US, ~110mm in India, and 33mm in UK first dosed.

Its all yesterday’s news, more like ancient history, as market commentators have shifted narratives to SPACs, inflation, style rotations, crypto, and the prescience of a bubble. Yes, SPACs have indeed been a mutating force with >$200b of market cap de-SPAC-ed since 2020 and another $250b waiting to deSPAC, which could — PIPEs willing — result in additional $1trillion + of market cap. Now, what has not changed is time tested sales principles of tying ebullient sales projections to rich valuations — never mind some de-SPACs that may not fetch a dollar of sales for years to come. No, I am not a bear, I am just pointing out the practical resemblances to the past, and perhaps the biggest pockets of excesses in an otherwise explainable market.

Inflation has always seemed a bit of red herring to me as its heaviest and immutably relevant components — rent, food, commodities — don’t tell the full story. The excess liquidity in the last decade has capitalized in the inflated financial assets and slowly but surely in alternative digital assets (more on that later) as the promises from tech bubble have been delivered in the past two decades — frankly, liquidity seems happy to stay put in these asset classes until the Fed decide to step back from the one-way street of expansion. Now, the inflation spooking the market this year is more imputed from the US 10 year action. To put that into perspective, 10 year yields had fallen from 3%+ to just under 2% in 2019 as all risk assets had rallied that year with no fear of inflation and the yields have now recovered back to under pre-pandemic levels from the lockdown lows in 2020.

So, what changed? The worries are spurred by the trillions of upcoming fiscal stimulus — odds of stimulus driven by deficits seem more likely vs. taxe hikes, but hard to tell. It is perhaps natural to obsess with unseen market levels but the ultimate force of gravity — interest rate remains unchanged and the Fed indicates all likelihood of a status quo for the next couple of years. The levels of liquidity also seem unlikely to recede. No, I am not a bull either, I am just pointing the irrelevance to obsessing with the market levels which can go a lot higher aided by these two factors, simply mathematically. Macro crystal gazing seems to be pointing to caution but not to clear signs of extreme caution yet, perhaps why Neils Bohrs said, “Prediction is very difficult, especially if it’s about the future.” and why timing the market may not be a good idea.

The immediate future seems to be upcoming S&P 500 Q1 earnings, albeit based on the past quarter — Sales are expected to be $30/sh (~10%) higher and operating earnings expected to be $20/sh (~100%) higher year over year and the expectations are similar for Q2. P/E for S&P 500 will revert back to low 20x should these numbers be achieved and it can run a good 20–30% before reaching its historical high multiples, or otherwise, pull back 10% on disappointments to more historical fair value levels. While the upside of investing in S&P 500 at 4000 is certainly lower than investing at pandemic lows, S&P 500 is a high quality asset class and a strong inflation hedge historically. As Ben Graham said in Intelligent Investor, “the risk of paying too high a price for good-quality stocks — while a real one — is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions”