COVID-19 Vaccination Update
As of February 2, 2021, 32.8 million Americans have now received at least one dose of a COVID-19 vaccine. That was more than those who tested positive for the virus. The average daily rate of vaccinations has reached 1.34 million doses per day. The average daily rate may be affected by the snowstorms of last week, but it seems to be trending upward.
Trading a Pullback
Valuations are staggeringly high. Nonetheless, I remain invested in equity for the portion of my portfolios intended for that.
Despite sky-high valuations, I am hesitant to take bold defensive moves. I have done so in the past, but this time around, I prefer to react to a meaningful pullback. Not predict it. The trade on my radar is to make slight adjustments from Large-Cap U.S. stocks to Small-Cap U.S. companies, as well as into the Emerging Markets (EM). I do own Small-Caps and EM now, but I am looking for a better entry point to increase my allocation. The EM exposure I have is through a buffer ETF; the Innovator Funds January series EM fund (symbol: EJAN). It’s a way to have EM exposure in a more protected manner than more conventional equity holdings.
U.S. Stock Valuation
The price-to-sales (P/S) ratio is a valuation metric. It is calculated by dividing the market capitalization of a stock, or group of stocks, by its annual sales. The P/S ratio’s more popular cousin is the P/E ratio (price-to-earnings). Like the (P/E) ratio, all other things equal, a lower P/S ratio is more attractive than a higher P/S ratio. The problem with P/E ratios is that everyone has different definitions of earnings: trailing 12-months, forward 12-months, a blend of time, GAAP earnings, “as reported” earnings, estimated earnings, earnings before interest, taxes, and amortization. Sales, however, are a bit more straightforward. There is a greater consensus as to what defines a sale.
As of January 26, according to Bespoke, the P/S ratio of the companies in the S&P 500 was 2.89. That’s about 75 percent higher than the S&P 500’s average P/S ratio of 1.65 since 1995. The Technology sector of the S&P 500 had a P/S ratio of 7.03. That’s more than double the average P/S ratio of 3.12 since 1995.
As shown on the blue line above, Bespoke shows that S&P 500’s current P/S ratio is higher than during the “dot com” bubble of 1999. The Technology’s current P/S ratio remains below its “dot com” peak of 7.87, but it’s not that far off.
Of course, there are lies, damn lies, and statistics. I am not excusing such high valuations, but it’s different this time. I remember, in 1999, having a money market account that was paying 6 percent. Today, interest rates are closer to zero. In 1999 there was H1N1, a form of swine flu. Today, the U.S. continues to suffer through a pandemic. And back then, investors were buying stocks just because they were going up in price even though they didn’t know anything relevant about the company.
Oh, wait. That’s happening now (*cough*GameStop*cough*AMC*cough*).
Well, I didn’t say it was better this time. I just said it was different. The major indices got cut in half following the bubble of the 1990s. I do not expect that this time. I feel as if sometimes I’m the annoying guy out there telling you that the sky is falling. But I do not expect the stock market to suffer the fate of being nearly cut in half, as it has done so three times over the last couple of decades. Will the stock market experience a big correction? Quite possibly. I even made a small trade last week considering this concern.
In my “moderate” portfolios, I have been uncomfortably overweight in Large-Cap U.S. stocks by investing in ETFs with an emphasis on Technology. I mostly targeted those positions to raise enough cash to initiate a 6 percent allocation to the Innovator Funds’ S&P 500 February buffer ETF (symbol: BFEB).
BFEB is designed to absorb the first 9 percent drop of the S&P 500. In exchange for that protection, the return is capped at 18 percent from February 1, 2020–February 1, 2021. Even in the face of an overvalued market, I wasn’t looking to add protection to portfolios. But I figured a 9 percent (or 19 percent) correction could begin any day now. And if it didn’t, and that protection turned out to be not needed, I can live with that upside return limit. If the S&P 500 advances 20% over the next 12 months, I am okay only making 18 percent, but with more safety.
I know that 6 percent is a small move, but it’s a move. I’ll keep watching to see if I should add more protection. But, as I said earlier, currently I’d rather ride the correction down and then consider rebalancing into Small-Caps and EM. I expect any correction to be short-lived because, in part, I think there’s a real good chance we’ll get another $1.9 trillion of stimulus from the federal government. It’ll be hard for the stock market to fight that off in the short term.
Even without that additional stimulus, the Congressional Budget Office (CBO) expects Gross Domestic Product (GDP) to return to pre-pandemic levels by the middle of 2021. In particular, the CBO calculates that the $908 billion relief package enacted in December would add roughly 1.5 percent to GDP in 2021 and 2022. Their expectations are for a U.S. GDP growth rate of 3.7 percent in 2021 and 2.4 percent in 2022.
Politics Unusual
The economy is transitioning in a manner that I have never seen before, so I remain cautious. Perhaps that says more about my personality than it does about my expectation for economic growth. I have never been, and never will be, a “home run” investor. I bat singles. I stay close to the base. I am winning the game, and I don’t need to risk swinging for the fences. (I don’t watch baseball, so I’m hoping I’m in the ballpark with those metaphors.)
It’s more important to me that I keep my money than that I add to it. But, yeah, I want to add to it. I believe the economy will grow fast enough to support and grow my investments. However, I am not so naïve as to dismiss the fact I’ve never before navigated the transition from a reopening stage of an economy to the early vaccination stage of an economy. In my humility, I took a bite out of BFEB. I am confident in my mathematics. However, the path of the economy remains inextricably linked to COVID-19. There is light at the end of the pandemic tunnel. But we have all been far too optimistic about the progress of eradicating COVID-19. First, we needed two weeks to flatten the curve. Then it would be over by Easter. Then it would go away in the warm weather of summer. Then we got mutant strains. It’s essential not to get too cocky with the coronavirus.
But why, then, such a small position in BFEB? And why so much equity exposure? The CBO sees the economy recovering. No disrespect to the CBO, but it’s not as if I’m going to rely solely on their forecast. I think the U.S. GDP will exceed the CBO’s estimate of a 3.7 percent growth rate.
Spending on both real durable goods (appliances, electronics) and nondurable goods (cosmetics, food, office supplies) are both above their pre-pandemic levels. (In economics, “real” means “adjusted for inflation”). Real spending on services rose a whopping 4 percent in the fourth quarter of 2020, but remains 6.8 percent below its pre-pandemic levels. The only services that did not see significant declines since February 2020 have been financial and housing services. Pent-up demand, additional stimulus, and further reopening of the economy should be a recipe for closing that service spending gap. I believe the right things will happen to nudge U.S. GDP growth to as high as 5 percent by the end of 2021.
My bullish view on the economy is grounded on the expectation of more fiscal stimulus spending. I believe the Biden administration will pass something resembling the proposed $1.9 trillion package. President Biden has said that doing something big and fast is important. He has also said that he would like to negotiate with the other side of the aisle. I’ll spare you the back-and-forth negotiations that have thus far occurred between Democrats and Republicans and get straight to the point. I believe President Biden will favor spending over bipartisanship. That’s not a dart thrown at President Biden specifically; I am tossing a dart in the direction of at all politicians involved with the law-making process.
On Monday, Feb. 1, top Democrats on Capitol Hill introduced a budget resolution. A budget resolution starts a process called budget reconciliation. Budget reconciliation would allow Democrats to pass legislation in the Senate with a simple majority instead of the 60 votes that would typically be required. The Senate is split 50/50, with Vice President Harris holding the tie-breaking vote. However, it’s not a done deal. The right-leaning Democratic Senator of West Virginia, Joe Manchin, will have to be courted for his vote.
Budget reconciliation is a procedural trick both parties have used in the last couple of decades. President Trump used budget reconciliation to pass tax cuts and then used it to try to eliminate the Affordable Care Act. President George W. Bush also used it to pass tax cuts. President Obama used it to pass the Affordable Care Act. I know there are long-term concerns about spending, but I have enough trouble looking at the horizon, never mind looking beyond it. I suspect that passing a $1.9 billion stimulus package will be a tailwind for the stock market and the economy in 2021. Past the horizon? Well, stay tuned.
Allen Harris is the author of “Build It, Sell It, Profit: Taking Care of Business Today to Get Top Dollar When You Retire,” as well as the owner of Berkshire Money Management in Dalton, managing investments of more than $500 million. Unless specifically identified as original research or data-gathering, some or all of the data cited is attributable to third-party sources. Full disclosures: https://berkshiremm.com/capital-ideas-disclosures/. Direct inquiries to aharris@berkshiremm.com.
