fbpx
Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Is the market cheap or expensive? This simple question is a constant source of debate among investors, who search endlessly for clues to support their bullish or bearish views. With stock prices hovering around all-time highs, and common valuations ratios for the S&P 500 index at levels not seen since 2008, I would be somewhat hard-pressed trying to make the case that stocks are historically cheap. That said, growth prospects in the economy can, in theory at least, justify just about any valuation level. 

One significant challenge in assessing today’s markets is the very high level of dispersion in stock valuations. While the market overall may look pricey, the picture gets murkier if we look under the hood to consider individual market components. Increasingly, different sectors that compose some of the main stock indices are behaving like totally different markets, and while that is always the case to some extent, the current level of disparity hasn’t been seen in decades. 

In its recent quarterly market report, JP Morgan provides some great data to illustrate the current situation. Since 1996, the level of valuation dispersion (defined as the difference between the 20th and 80th percentile) for stock valuations in the S&P 500 has been 11.0 on average; today the current valuation spread is 19.7. As shown below, the spread is the highest it’s been since 1996, and you’d need to go back over 20 years, to the early 2000s, to find comparable dispersion.

In practice, it means that in today’s world, a sector like consumer discretionary (which includes Amazon and Tesla), is more than twice as expensive as some of the cheaper sectors, like financial services or energy.

The theme of valuation spread yields equally striking results when considered from a different angle: country and regional valuations across the world, rather than between U.S. sectors. As shown in the chart below, the valuation spread between the most expensive region (the U.S.) and the cheapest (emerging markets) is currently at levels not seen since, once again, the early 2000’s.

What should investors make of this increasingly disparate world? Investing would be much easier if we only had to look for cheap valuations to infer future returns, but in fact, cheap stocks may turn out to be value traps. Valuation metrics such as Price to Earnings ratios (PE) are meaningless in isolation, and must always be interpreted in the context of a company’s growth prospects. In other words, high valuation levels aren’t necessarily “expensive”, and low valuations aren’t necessarily “cheap,” just like an inexpensive used car isn’t always a good deal. 

In recent years, buying the most expensive stocks has been the winning strategy, as they continuously grew into higher and higher valuations. Every trend eventually comes to an end, and extreme positioning could be an early sign of a potential reversal. The early 2000s were, in hindsight, a transition period between the roaring 1990s and the lost decade of the 2000s. Eventually, paying an ever-growing premium for trendy stocks will leave investors chasing increasingly unrealistic growth targets. In the context of a well-diversified portfolio, it might be time to take a closer look at today’s unloved stocks, with a bit of luck, we might just find a good deal.

Syl Michelin, CFA®

The Case for Using Dividend-Paying Stock in a Yield-Starved Market

The Case for Using Dividend-Paying Stock in a Yield-Starved Market

As we look to the second half of 2021 and take an assessment of the markets one year after the post-pandemic recovery began, it’s frankly difficult to feel anything but extremely relieved and grateful that global markets faithfully marched onward through human tragedy, political turmoil, and the Aaron Rodgers pseudo-holdout that followed a second straight defeat in the NFC title game. Clearly, the market has been more like Tom Brady than Kirk Cousins, continuing to win even though the run has left both Brady and the U.S. stock market’s bull run a bit long in the tooth, but still hard to bet against.

However, as we turn the page on the first half of 2021 and look ahead to 2022, it’s hard to ignore valuations and worry that, like the Minnesota Vikings, money put to work here and now may give us a Kirk Cousins-like vibe sooner rather than later, meaning that we run the risk of overpaying for expectations that may be beyond our grasp or control. In short, valuations matter, and we shouldn’t give stocks or our quarterback a blank check.

But the core issue facing investors should rarely, if ever, be whether to invest, but where to continue to invest, or how to properly allocate their investments. That seems even more important than ever when we look at the following relative performance metrics over the past 12 months (August through July), based on the total return of popular ETFs tracking the following indexes:

%

S&P 500

%

NASDAQ 100

%

Russell 2000

%

MSCI EAFE (Developed Markets ex: US)

%

MSCI Emerging Markets

%

Barclays Aggregate U.S. Bond Index

That’s an impressive throttling by all major stock markets versus the bond market! Looking closer, and perhaps not surprisingly, the relative return of various stock markets appear to be inversely related to the dividend yield generated by each respective index. Here is an approximate 12-month trailing yield for each of the ETFs upon which these stock index returns were calculated:

%

S&P 500

%

NASDAQ 100

%

Russell 2000

%

MSCI EAFE

%

MSCI Emerging Markets

I would argue that interest rates played more than a minor role in the relationship between valuations, dividend yields, and the outperformance of high-valuation/low-dividend-paying (or we could use the oversimplified term “growth”) versus the lower-valuation/higher-dividend-paying (“value”) stocks over the past year (and going back over the past several years going back to the Great Recession). When interest rates are abnormally low, the “valuation” of the distant future earnings promised by younger, fast-growing companies is distorted by an abnormally low “discounting” of the future earnings, because the discounting is based on prevailing interest rates. Thus, lower interest rates result in a higher present value calculated for companies that promise massive earnings in the more distant future. 

So what happens should interest rates rise, or even rise dramatically? That would tend to have a more negative effect on the valuations of companies with future projected earnings streams that are more back-end-loaded (meaning the bulk of the future earnings are still several years out from today). We’ve seen this play out in the Russell 2000 and the Nasdaq on trading days when interest rates climb on robust economic data (e.g., a strong employment report), often resulting in considerable rotation out of the growth stocks and into “safer,” or “blue chip” stocks that have lower valuations and, quite often, pay dividends out of the company earnings on a regular basis.

Therefore, while rising interest rates are a substantial risk to bond holdings and, arguably, growth stocks that have dramatically outperformed in recent years, the allure of dividend-paying stocks appears rational from both a risk management and a valuation perspective going forward. This volatility (risk management) and return proposition have always been true, but relative underperformance of dividend payers in recent years may increase the odds that dividend payers will enjoy a more profound comparative risk/return profile going forward.

A study by Ned Davis Research and Hartford Funds compared the relative average annual returns and volatility (measured by the standard deviation of returns) of dividend payers in the S&P 500 versus those companies in the S&P 500 that did not pay a dividend. The study examined return data over a very long period: March 31, 1972, to December 31, 2019. It was discovered the dividend payers enjoyed average annual total returns of 12.9%, which was a dramatic outperformance compared to the average annual total return of 8.6% by S&P 500 component companies that did not pay dividends. The relative volatility characteristics of the dividend payers versus the non-dividend payers were equally profound. The average standard deviation over the study period for the dividend-paying component companies of the S&P 500 averaged 15.6% versus a staggering 24.3% average standard deviation for the non-dividend-paying component companies! The upshot is undeniable: Dividend-paying stocks provided both superior returns and lower risk for their investors, a proverbial best of both worlds.

We also want to share some additional points for those investors who want to harvest some (if not all) of the income from their portfolios: Where else but dividend-paying stocks are you going to find yield today, tomorrow and in the years to come? While the potential for rising bond yields in the future increases the potential that bonds may one day again provide a meaningful income stream for investors, this would very much come at the expense of bonds that have already been issued. In other words, bonds carry interest rate risk, and the further out the maturity for the bond, the higher the interest rate risk. Moreover, bonds also carry substantial inflation risk, meaning that the risk that rising prices will reduce the value of the interest stream (coupons) paid by bonds and also the purchasing power of the principal that is promised to the investor when the bond matures. While stocks, even dividend-paying stocks, carry some interest rate risk and also inflation risk, stocks and particularly dividend-paying stocks have distinct advantages. For one, companies can, to varying extents, pass rising costs of doing business on to their customers. Similarly, dividend-paying companies can increase their dividends over time, while most bonds pay fixed sums of regular interest.

Accordingly, for years, the global stock markets have risen in part on their relative attractiveness compared to bonds in a low-interest-rate environment. These stock markets might continue to do so in a rising interest rate environment, and/or in an inflationary environment. However, not all stocks are equally up to the challenges of rising rates and inflation. Those companies with relatively higher current earnings power and those companies that can increase their income payouts to shareholders should be better positioned to weather either, or both, storms and, therefore, we believe that they can play a very important role in investors’ portfolios going forward.

Stan Farmer, CFP®, J.D. 

DISCLOSURES
Walkner Condon Financial Advisors is a registered investment advisor with the SEC and the opinions expressed by Walkner Condon Financial Advisors and its advisors in this article are their own. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice.

Information presented in this article is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed.  

Information in this article does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Readers are encouraged to seek advice from a qualified tax, legal, or investment advisor to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.

Year of Electric Vehicles: What will Shape EV Trend in 2021?

Year of Electric Vehicles: What will Shape EV Trend in 2021?

The ascent of Tesla, both in valuation and ingenuity, has been one for the ages. Elon Musk has been a polarizing figure, but it is certain that he has strongly contributed to the adoption of electric vehicles (EVs). Despite the limitations of the range of the vehicles, lack of charging stations, and a premium price, consumers are increasingly becoming interested in owning vehicles that are seen as more friendly to the environment.

Acceleration of Choice

While Tesla vaulted out to a head start, offering cars that are both functional and fashionable (certainly relative to the Chevy Volt or Nissan Leaf), automakers are expected to roll out EVs in 2021 at a much more rapid pace. Rolling Stone wrote an article on “12 Electric Cars to Look Forward to in 2021”, featuring some of the most anticipated offerings. Ford will enter with a version of the Mustang, Mercedes will have a luxury offering, and we will even see an electric version of the (formerly) gas-guzzling Hummer. More startups will potentially offer their electric vehicles in 2021 as well, with rumored EVs coming from Rivian and Lucid, among others. 

But…..Tax Credits are Starting to Run Out!

Did you know that there is a generous $7,500 tax credit for buying an electric vehicle? If not, this may be an attractive benefit that may cause you to look closer at EVs. While these cars are almost always more expensive than their gas-powered cousins, this is an attractive benefit. The downside is that once 200,000 cars are sold by a manufacturer, this tax break evaporates….so say goodbye to the tax credit for Tesla and GM. That being said, the Growing Renewable Energy and Efficiency Now (GREEN) Act – still in its early stages – could move the tax credit threshold to 600,000 cars, if it passes. That legislation would carry with it a $7,000 tax credit for vehicles sold between the 200,000 and 600,000 thresholds. 

To find out more on who is eligible, see this blog post. The U.S. Department of Energy also offers this really helpful car-by-car breakdown of tax credits and phase-out timeframes. 

Growing Charging Networks

According to an EV charging blog post from Car & Driver, “most plug-in owners charge at home over 80 percent of the time.” For those that find themselves running low or unable to charge at home, the charging networks have quickly been growing. Tesla has its own charging networks exclusive to their vehicles, and there is an industry standard called SAE J1772, or U.S. Standard Level 2, that will work with every electric vehicle on the road today. Additionally, there are DC fast-charging stations that are becoming more available that will charge batteries at a much more rapid rate.

A close-up view of two different types of charging ports in an electric vehicle

A peek under the “hood” of an EV charging port. The standard J1772 electric power receptacle (right) can receive power from Level 1 or Level 2 charging equipment, while the CHAdeMO DC fast charge receptacle (left) can charge a battery up to 80% in two hours. Photo source: energy.gov

What About Fuel Costs?

For EVs, it’s all about the kilowatt-hours (kWh). Here is a good resource from the U.S. Energy & Information Administration to determine kWh costs near where you live. In Wisconsin as of the writing of this blog post, it was 14.80 cents/kWh on average for residential residences. That doesn’t tell the whole story, however. Kilowatt-hour cost will vary depending on when you access the power grid, so charging at strategic times is beneficial to keeping your costs down. Tesla has some capabilities built in to take advantage of this, turning on the charging at optimal times as well as syncing with your calendar to determine how much you will be driving the next day and therefore how much charging it should do.

So is it less expensive to “fill up” an EV versus a gas-powered car? It’s likely but not certain, as it will depend on whether you use a fast-charging system and it again depends on when and where you do the charging. Read a bit more on the nuances of fuel costs here.

So Are Electric Cars a Good Investment?

We always cringe when we have the moniker of “investment” placed on an asset that is depreciating over time. Conventional wisdom says that EVs being the hot cars of the moment would lead to better resale value; however, with battery technology improving and many more choices becoming available in the market, resale numbers are looking worse, not better. However, with its over-the-air updates, Tesla seems to be an exception to the rule. Even then you may be only a short while away from a game-changing technology that renders previous battery technology obsolete, such as “solid-state” batteries, an exciting and fascinating recent development that could change cars forever. While EVs are certainly going to be massively implemented during the decade of the ‘20s (with even more exciting developments in self-driving technology!), it’s hard to claim that these will be solid investments that will hold their value. 

Clint Walkner

INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.

Fixed Income: COVID recovery, economic growth are key factors in 2021

Fixed Income: COVID recovery, economic growth are key factors in 2021

The novel coronavirus brought upon us unprecedented shutdowns and economic turmoil in the first half of 2020, and there was no greater impact on righting the ship than the Federal Reserve. In the midst of our economy grinding to a halt and our GDP cratering, Federal Reserve Chairman Jerome Powell brought interest rates down to zero, and the central bank used a number of different tools in its repertoire to help the struggling economy and businesses navigate the shutdowns. These moves helped to prevent an even more dire situation, but it has left investors that rely on fixed income in a precarious position in the trade-off for receiving steady income from your money vs. the risk of capital to reach for a higher yield. 

2020 returns on fixed income securities were strong due to the actions of the Fed. When interest rates drop, the price of bonds goes up, and you tend to see higher returns. It does not seem likely that the Fed will raise interest rates in 2021, and that could be as far out as 2023 if the economic impact of COVID-19 continues to dampen the U.S. economy. This portends a positive outlook in the short term for bond investors, but yields on fixed-income investments will more than likely be lower for longer due to the outlook for short-term rates. This does not mean that fixed income will not be an important part of a diversified portfolio for 2021 and beyond, however.

Money-Market and Cash Deposits

The short-term road for cash and money market investments looks bleak as the short-term rates are expected to be kept at, or near, zero moving forward. It will be difficult to earn a meaningful return on these deposits, but they will continue to be attractive for defensive investors who do not want to lose principal because of the lingering economic uncertainty due to the coronavirus, a new administration, and new Congressional economic policies.

Treasuries

With the economy continuing to recover and the COVID-19 vaccine in the process of being rolled out, we should see the yield on the 10-year treasury increase. The Federal Reserve looks to normalize this yield as the economy strengthens, seeking to control inflation. If inflation increases as it is expected to, we could see intermediate yields rise and reach a range of 0.5% to 1.6%. Short-term rates will more than likely remain at or near zero as the Fed wants to continue to prime the pump of the economy and keep money cheap.

Graph of the 10-Year Treasury Yield Comparing Nov. 2019 and Nov. 2020

Source: Bloomberg. 10-Year Treasury Yield and a Proprietary Multifactor Fair Value Model of the 10-Year Treasury, using JPMorgan Global PMIs, Inflation Swaps, and the Term Premium. (USGG10YR Index, MPMIGLMA Index, FWISUS55 Index, ACMTP10 Index). Using monthly data as of 10/31/2020. Past performance does not guarantee future results.

This should help businesses borrow to remain in business and even expand as the economy continues to recover. Treasuries are attractive because they are safer investments due to the fact that they are backed by the full faith and credit of the U.S. government. In the risk-reward world, this causes them to have less of a return than other fixed-income investments that require more return for the inherent risks of investing in them. Their safety and relatively modest returns should continue throughout 2021.

Treasury Inflation-Protected Securities (TIPS) can be helpful to fixed income investors in 2021 and beyond to protect against inflation risk during a rising interest rate environment and can be an important part of a fixed-income portion of a portfolio. With short-term rates having nowhere to go but up, they should be a good inflation hedge.

Corporate Bonds

2021 should create an opportunity for investment-grade corporate bond investors, but it is important to look to keep duration shorter in these investments. Duration is the time it takes for a bond to return the coupon and principal back to an investor; it can fluctuate based on interest rate changes and can be managed through diversification and bond-laddering. Credit quality is important as well because ultimately, these investments have the risk that the bond issuer could become insolvent—though at least the bondholders are ahead of the shareholders in line for payment in a bankruptcy proceeding. If you are looking for higher-yield bond returns, then you will more than likely need to invest in issuances that have more credit-quality risks. With bond yields being lower due to lower interest rates, it will be important to guard against overexposure to these investments in the search for a higher-yielding portfolio.

Global Bonds

The global bond outlook for 2021 will have a lot to do with how the valuation of the dollar moves. If the dollar weakens as it did at the end of 2020, then we should see strong overall returns in this asset class as the native currencies strengthen. As the U.S. government continues to stimulate the economy with an influx of borrowed money, and the Fed’s policies remain dovish, global bonds should become more attractive for foreign investment to fill the gap due to low yields and returns on U.S. debt. Improving global economic conditions as we come out of the coronavirus pandemic, in addition to accommodative central banks, should make this an attractive asset class in 2021. However, there is still more risk in global bonds than in U.S.-backed treasury bonds and other higher-quality issuances.

Summary

It is difficult to predict how soon the U.S. and global economies will recover from the COVID-19 pandemic. But, if there is continued economic growth, investors could find yield and returns in fixed-income. It could be a choppy year in these asset classes as central banks continue to use their tools and programs to stabilize the economy, so it will be important to monitor quality and diversify your fixed-income holdings.

Jonathon Jordan, CFP®

2021 INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.

The Evolution of the S&P 500: Where Do We Go From Here?

The Evolution of the S&P 500: Where Do We Go From Here?

The year of 2020 was a very strange one indeed. For the U.S. stock market, however, if you looked at the beginning and the end of 2020, you’d see the S&P 500 up about 16.6% and conclude that this year was merely more of the same ol’ U.S.-dominated bull market that prevailed throughout the prior decade as U.S. stocks led global markets out of the very deep bear market experienced during the Great Recession. The leadership experienced by the blue chip S&P 500 stocks over smaller stocks indeed persisted in 2020 just as large caps have outperformed small and mid-cap stocks over the bulk of the post-recovery bull market. The similarities don’t end there, as 2020 was a year again dominated by winning sectors within the S&P that have been doing the heavy lifting for quite some time, led by mega cap darlings that epitomize innovation and success in their dominance of our digital economy. Here are the top three sectors ranked by performance in 2020:

  • INFORMATION TECHNOLOGY (THINK APPLE & MICROSOFT) +42.8% +42.8%
  • CONSUMER DISCRETIONARY (THINK AMAZON) +32.3% +32.3%
  • COMMUNICATIONS SERVICES (THINK ALPHABET, FACEBOOK & NETFLIX) +22.4% +22.4%

Yes, those predicting the demise of “FANG” stocks are going to have to wait at least another year (or another 10 years) for vindication, because COVID-19 not only caused investors to gravitate toward what few stocks were still showing earnings growth, it actually caused businesses and consumers alike to lean even more heavily on the digital economy in their day-to-day affairs to navigate the new reality of pandemic, lockdowns, and social distancing. Indeed, it’s entirely fair to say that many of the trends that had long benefited the digital economy stalwarts, such as the migration to social media, streaming entertainment, online shopping, etc. truly accelerated further because of the Covid-induced recession.

On the other side of the coin, 2020 and the Covid-induced recession predictably brought on hard times for those parts of the S&P that contracted sharply from an environment of staying at home, shopping online, and near-zero prevailing interest rates. These are the three worst performing sectors of 2020, which all managed to finish in the red (as did utilities) in a well above average year for the S&P 500 on the whole (percentages shown are negative):

  • ENERGY (THINK EXXON, CHEVRON & SLUMBERGER): 36.9% 36.9%
  • REAL ESTATE (THINK SIMON PROPERTY GROUP & MARRIOTT) 4.6% 4.6%
  • FINANCIALS (THINK JP MORGAN CHASE & BANK OF AMERICA 3.8% 3.8%

So, we see that 2020 was a year that no one will likely ever forget, and yet, from the perspective of the S&P 500 index, it was very much a continuation of 2019 and before, with the largest growth stocks leading a new digital economy and doing almost all of the heavy lifting underneath the surface of a rampaging S&P 500, while value/dividend investors suffered yet another disappointing year of dramatic underperformance.

Let’s put this technology-driven trend in proper perspective, comparing the S&P 500 at the dawn of the post-Great Recession recovery to the end of 2020. Pulling figures from this blog from DataTrek research last March, let’s consider the migration during this nearly 11-year period for the leading and lagging sectors of 2020 in terms of their share of the overall S&P 500. Keep in mind, of course, that the communications services sector did not exist in 2009, so we’ll follow DataTrek’s appropriate and reasonable lead and put Alphabet and Facebook back in the technology sector, and return Disney, Comcast and Netflix back to the consumer discretionary sector (leaving the traditional telecom stocks out of the equation as there is no comparing the old telecommunications sector with the current “communications services” sector). Likewise, real estate was not a recognized separate sector in 2009, so we must also return the real estate stocks to the financials sector to fairly compare 2009 and 2020 figures. Here are the approximate weightings in the S&P 500 for the traditional technology and consumer discretionary winners of 2020 and the energy, real estate and financials laggards of 2020 vs. their relative S&P 500 weightings in March of 2009 (the dawn of the great bull market recovery):

SECTOR WEIGHT END-OF-YEAR 2020 WEIGHT END-OF-Q1 2009
TECHNOLOGY

32.3%

18.0%
CONSUMER DISC. 14.2% 8.9%
ENERGY 2.3% 13.0%
FINANCIALS 12.8% 10.8%

Those numbers put the two obvious megatrends at the sector level within the S&P into a clear numerical perspective. First, technology was the largest sector at the dawn of the post-Great Recession bull market, and its share of the S&P 500 pie has somehow doubled in size during this period to now constitute nearly one-third of the index. Second, companies that extract dinosaur fossil materials (energy) from the earth are now on the verge of extinction within the S&P, as energy’s sector weighting declined about 82% during this period.

As Clint’s discussion of the electric car megatrend thoughtfully points out, Teslas consume energy, too, right? Clearly, the secular and technological changes in the industry that brought oil below $20 at one point in 2020 have dramatically altered investors’ appetites for crude and its derivative products, and the ESG trends that Mitch discusses clearly aren’t helping, either.

Trends persist, often much longer than most imagine they can persist, and this has been a classic example within the S&P 500 for years. However, there is no bigger curse for investors than to be late to the party. Even the most persistent trends eventually give way and reverse course, and often violently. Think NASDAQ circa 2000 with the pricking of the internet bubble. That was a painful time for many investors that bought into the idea that the secular trend of internet adoption would rewrite the rulebook on investing and that traditional fundamental analysis of technology/internet investments was no longer applicable. This was an age when I distinctly remember repeatedly hearing the most dangerous four-word sentence on Wall Street: “This time it’s different.”

Would we dare utter those words today? What if I told you that the Information Technology sector of the S&P 500 in December was trading around 45 times trailing one-year earnings, and about 40 times the estimated earnings for the coming year, while the Consumer Discretionary sector was trading at 85 times trailing one-year earnings and 38 times estimated earnings for the coming year? That seems quite frothy indeed. This illustrates a major premium that has been paid (and continues to be paid) for growth, not at a reasonable price, but at any price, in a world where there was (and there remains) a scarcity of growth (i.e., the Covid-induced recession). 

However, there are many metrics by which we can judge the current S&P 500 in the context of history. I recently revisited one thoughtful article from October 2018 by a very seasoned Wall Street veteran who expressed concern about the froth within the S&P 500 back in 2018, echoed my revulsion of the most dangerous sentence ever heard on Wall Street, but keenly observed that adjustments in historical time frames could dramatically alter the perception of relative froth in the S&P 500. There truly is a data point for every argument.

Therefore, as we happily put 2020 in our rearview mirrors and look to the future promise of 2021, what can we expect for the S&P 500 and its component sectors? Prognostications are dangerous and common sense negates the follies of both ignoring a trend and blindly riding a trend into oblivion. In other words, it would be unwise to overly commit to the notion that, because the S&P 500 has led world stock markets, and technology, communications services, and consumer discretionary stocks have dominated the S&P, that you should cash in your chips and place all bets elsewhere. On the other hand, the magnitude of the outperformance of the S&P 500, and particularly of those sectors and mega cap stocks most responsible for that outperformance, has increased the risks associated with those investments relative to other sectors within the S&P 500 and relative to other stock indexes, foreign and domestic. 

The prescription for navigating the market ahead is an ageless remedy:

  • Examine your portfolio and the underlying allocations to U.S. stocks, to sectors within those U.S. stock holdings, to non-U.S. stocks, to bonds, to alternative investments, etc.;
  • Determine the extent to which the trends discussed above have left your portfolio over-exposed to U.S. stocks and particularly to the growth stocks and the favored growth sectors that have led the S&P 500 to new heights in 2020; and
  • If you determine that the weightings in your portfolio make you uncomfortable with the potential eventuality that money flows reverse away from these investments into more neglected segments, sectors, and regions within the global stock markets, then by all means REBALANCE — sooner, rather than later.

Given the new highs for all the major stock indexes in the U.S., it is probably safe to assume that investors, in general, are anticipating a smooth rollout of Covid vaccines as we move into 2021 and a major economic rebound as life starts to return to something resembling normal. If this occurs, we could very well see outperformance in sectors of the S&P 500 that massively underperformed in 2020, and that could very much come at the expense of 2020’s market stalwarts. After all, for money to move to the less-loved sectors of the S&P, it has to come from somewhere and, right now, practically one-half of the money in U.S. blue chips is in technology (infotech and comm. services) and consumer discretionary stocks. More breadth in a rising market would be quite welcome. However, only time will tell whether and to what extent the underlying economy will have a robust recovery and to what extent the current pandemic has produced long-term fundamental shifts within the economy that could provide continued challenges for certain sectors and industries within the domestic and global economy. 

Stan Farmer, CFP®, J.D. 

2021 INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.

Another Banner Year or Start of a Drop? The 2021 U.S. Real Estate Market Outlook

Another Banner Year or Start of a Drop? The 2021 U.S. Real Estate Market Outlook

The challenges of 2020 were numerous and seemed unrelenting at times. It was difficult to find the silver lining in a year full of grey clouds. That said, there were a few bright spots in the financial world. The three major U.S. stock indices were all positive for the year as well as the domestic real estate market. Despite the headwinds of COVID, high unemployment, and strained budgets, real estate values continued to push higher with low inventories and historically low-interest rates helping to fuel the fire. The housing market will correct at some point, as all markets do, but will 2021 be the beginning of the drop or another banner year? 

A Brief Recap of 2020 

The U.S. real estate market posted another strong year of sales in 2020. The energy from 2019 continued right on through the majority of 2020. Due to COVID ramping up in the U.S., the first quarter and the beginning of the second quarter forced real estate professionals to adjust from in-person showings and open houses to a more virtual environment. Buyers adapted well to these changes and continued their frenetic pace. Attractive interest rates and low inventories created the perfect environment for sellers to receive top value for their homes.     

The Factors That Could Derail The Housing Market

The landscape for the 2021 real estate market looks quite encouraging, according to many of the experts in the industry. There are a few factors that will have a significant impact on the real estate market. These three factors are especially important because any one of them could be the impotence for a market cool down: 

1. COVID – We have all adjusted our lifestyles to best protect ourselves from the pandemic by reducing contact with others, limiting our travel, and wearing masks. However, if the pandemic really begins to accelerate or a new strain is introduced and causes panic, we could see people limit their exposure events further. Furthermore, if job losses increase, this could make potential buyers and sellers pause any housing activity. This could have a big impact on people’s willingness to go through the buy/sell process.

2. Remodeling – The “new normal” of working remotely and being more self-sufficient at home is creating a perfect environment for people to remodel their existing homes to better fit this lifestyle. People are renovating kitchens, finishing lower levels, and adding offices and workspaces to adapt. This runs counter to the idea of selling a current home and upgrading to a home with those features already in place. The demand for remodeling will likely create the momentum for another positive growth year in that sector.

3. Jobs – The U.S. economy has struggled with high unemployment as a result of the pandemic. Typically, high unemployment will absolutely slow down the real estate market, however, the housing demand stayed strong throughout 2020 in spite of high unemployment. That said, if the unemployment numbers worsen into 2021, then housing may start to feel the effect. 

The Tailwinds That Could Power The Market Through 2021

1. Housing Inventory – For the majority of markets in the U.S., the number of houses on the market isn’t enough to satisfy the number of people looking to purchase a home. This imbalance has helped to push values higher and keep the real estate market momentum strong over the last few years. However, if this imbalance corrects itself by a jump in new construction or more people deciding to sell their homes, the market would adjust and values would flatten out. The chief economist at Realtor.com is predicting new home starts will be up 9% in 2021. However, it doesn’t seem likely to slow the demand in 2021 as both of those variables take time to influence the market.

2. Interest Rates – Mortgage rates have been trending down over the last 2+ years as the 10-year Treasury yield continues to fall. The relationship between mortgage rates and the 10-year treasury is quite strong and has been decades. The friendly interest rate environment being utilized by the Fed is likely to continue, at least into, if not through the year 2021, which will keep mortgage rates at or near all-time lows. This is a huge motivating factor for buyers looking to purchase a home.

3. COVID Vaccines – While the initial rollout of the COVID vaccine is running at a slower pace than what was predicted, the experts believe that we will be back on track within the next month or two and hopefully have the majority of Americans vaccinated by mid-year. This could go a long way to instill confidence in the general public and provide additional fuel for an already hot real estate market, especially if real estate professionals can resume in-person showings for the late spring and summer months. The summer months could be phenomenal if consumer confidence accelerates. 

Outlook for 2021

Barring any unforeseen circumstances, as we all struggled with in 2020, the trends are leaning towards another strong year in the real estate market. We are likely to see the tailwinds mentioned earlier prevail for the entirety of 2021 and demand should continue at the previous year’s pace as a result of not enough inventory. Real estate markets, especially in the Midwest, tend to correct slower than the stock or the bond markets. The coastal markets in the U.S. do move faster and will be more susceptible to unpredictable events; however, the momentum is still strong across the country. The variables are in place for demand to outpace supply and attractive financing options to continue for at least 12 more months.

Nate Condon

2021 INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.