The stock market continued its upward sloping trend during the first quarter, as a third stimulus package along with the most dovish Federal Reserve we have witnessed during our more than 30 years in business provided the necessary tailwind.
In addition to the above, the robust rollout of a choice of COVID-19 vaccines from three different pharmaceutical companies makes an exit from this health care crisis very likely during the latter part of the second quarter which in turn should unleash a wave of spending as a result of the pent-up demand from consumers.
In addition to the above, many of the coincident and lagging economic indicators have picked-up considerably. Just this month a report from the Institute for Supply Management detailing the pace of economic activity in both the manufacturing and service sectors rose to pre-pandemic levels.
Non-Farm Payrolls expanded by over 900,000 jobs during March and in doing so pushed the Unemployment Rate down to 6.0% from 6.2%, the Labor Force Participation Rate up to 61.5% from 61.4%, the Underemployment Rate down to 10.7% from 11.1% and extended the number of Average Hours Worked to 34.9 during March from 34.6 one month prior.
So then what could derail this bull market? – certainly a new strain/variant of the COVID-19 virus that is immune to the current slate of vaccines, overvaluation from a parabolic move higher in stocks as a result of a blow-off top, an overheated economy for an extended period of time or persistent inflation that is not addressed by tighter monetary policy from the Federal Reserve.
For now and in our opinion, we do appear to have a stock market that is rich in valuation on a fundamental basis and a bit extended technically which could portend a normal, garden variety pullback but nothing more. In addition, despite the economic data noted within the second paragraph, we would consider the recent pick-up in economic activity as expected given the fact the economy has been locked down for nearly a year.
However, we do believe this to be somewhat temporary as investors will soon begin to look toward 2022, a year which may include higher levels of taxation for individuals as well as corporations, a natural headwind to economic activity.
At this time we agree with Federal Reserve Chair Jerome Powell who recently observed that “with inflation running persistently below 2 percent, we will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”
Powell went on to state that the Fed will continue to maintain an accommodative monetary policy “until labor market conditions have reached levels consistent with the Committee’s assessment of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. I would note that a transitory rise in inflation above 2 percent, as seems likely to occur this year, would not meet this standard.”
In our opinion, if the recent pick-up in inflation as measured by both the Consumer as well as Producer Price Indexes proves more than transitory the result will be higher interest rates and a Fed that will reduce bond purchases and perhaps hike short-term rates sooner than the market is currently anticipating.
As we look to the future, our strategy in regard to equities is to continue to think long-term, live through short-term volatility and maintain an overweighting in our strongest conviction stocks, ETFs and mutual funds. We continue to invest in securities that grow their earnings but are priced reasonably (GARP) and despite the recent trend to contrary, continue to believe secular growers will outpace cyclical offerings over a full economic cycle.
Regarding fixed income, we find little potential in this asset class and yet are keenly aware of the necessity for purposes of income and diversification. We are also wary of longer-dated fixed income securities, including preferred stock.
In closing, as the financial markets are forward-thinking, discounting mechanisms, it is logical that the greatest gains in value occur during periods of greatest economic stress, which is why stocks performed so well during 2020. As we prepare for the future, we expect a period of heightened volatility and choppiness.
It comes with the territory and is not to be feared.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.