Big Picture Pros and Cons

A new year brings a flurry of investment predictions. While putting precise targets on where markets end the year is silly, working through a list of big picture pros and cons is a good intellectual exercise. Markets are forward-looking, and this exercise helps un-anchor from the events of the past and take an inventory of the future. Here is a list of a few things that I consider important. Here are the Pros.

Always bet on human ingenuity. The list of potential setbacks is long: 1) The vaccines might not be as effective as advertised, 2) new strains might accelerate the spread of Covid, or 3) a large portion of the population might not take the vaccine. However, I believe the likely case is that vaccine logistics and treatment availability will improve, and most at-risk populations will receive a vaccine. This points to a higher probability of ‘life back to normal’ in 2H 2021.

Strength begets strength. Public companies survived due to their scale while small businesses took the brunt of Covid. As we return to normal, the scale benefits will magnify the competitive advantages of larger enterprises. This is an underappreciated element of the market advance.

Durable operating leverage. Businesses were forced to rapidly cut costs during Covid. Revenues will grow faster than expenses as the economy returns. Earnings growth will remain strong and profit surprises will continue for multiple quarters.

Improved household finances. It has taken more than a decade for consumers to recover after the near-death experience of the financial crisis. A combination of forced savings of ‘everything from home’ in 2020 and help from government stimulus has left consumer finances in a strong position.

Strong new business formation. The latter half of 2020 had the highest new business formation in over 15 years. Large cloud platforms, social networks, and global marketplaces have created a plug and play system for new business owners. Entrepreneurs can focus on their core skill set and outsource the rest.

Here is a list of Cons…

Peak QE. The Fed is growing the money supply by 25% annually. It is unlikely that this rate of money pumping will be surpassed and therefore serve as a headwind to market multiples.

Interest rates are too low. The justification for above-average valuation is based on historically low-interest rates. If rates stay this low over the next 5 years, stocks will go a lot higher. However, a rebounding economy and economic stimulus will force interest rates upwards. While this is a normal course for a typical economic cycle, this cycle is quite atypical. A rapid rise in interest rates will be turbulent for markets.

Valuation above average. While current market valuation is above average, it has to be viewed in the context of ultra-low interest rates and a once in a 100-year pandemic. Most businesses will get back to a normalized earnings trajectory in 2022-23. Understanding valuation within that context makes it a mild negative.

Return of the individual investor. The rise of the Robinhood trader has brought on a new level of option speculation. The size of YOLO (you only live once) speculation has grown and this lottery call option buying is the biggest near-term risk to the market. However, this is a microbubble that will dissipate over time without causing a major market event.

​In hindsight, 2010 or 2017 was a great time to invest, but felt uncomfortable, or at times …. wrong. 2021 is no different. As investors, it is paramount to look at opportunities and risks dispassionately. Valuation is a deterrent to returns at extremes, and we are far from that. We are emerging from a deep recession, with a long runway for economic and earnings growth. Markets have partly anticipated that and are likely to enter a period of consolidation (choppy sideways move). In the big picture, the pros outweigh the cons by a large margin and we are still in the early innings of a multi-year market cycle.

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This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the Fund.  These projections are included for illustrative purposes only, are inherently speculative as they relate to future events, and may not be realized as described.  These forward-looking statements will not be updated in future.