thoughts approaching midyear

2021 has been surprisingly good for stocks, so far.

It’s not 2020-good, but what could be? Last year was a stew of pandemic-induced economic disaster compounded by Trump’s hide-under-the-bed inability to function in a crisis. The combination triggered a Fed stimulus enormous enough to drive the 10-year Treasury from a 1.88% yield on January 1st to 0.55% during the summer. The stock market response was to rise very sharply and, given Washington’s dysfunction, with a strong emphasis on secular growth names and on multinationals.

The 2020 rally began to shift emphasis in early November, when it became clear that Trump would not be reelected. This realization sent the Russell 2000, which focuses on domestic names–and which had been a significant laggard to that point–on a tear that continues to date.

The year to date performance of the major US indices as I’m writing on Wednesday morning is as follows:

R2000 +16.6%

S&P 500 +15.0%

NASDAQ +12.9%.

Even the ARK Innovation ETF (ARKK), which was up by 158% last year, is up slightly, at +3.2% so far in 2021. Admittedly the ARKK ride has been wild, with the ETF ahead by 25% early on, before plunging to -20% by April and recovering to just above breakeven now.

If the year ended today, no one could reasonably complain about 2021 performance.

issues for the second half

–interest rates. It’s pretty clear that rates aren’t going down from here. The real questions are when they’ll start to rise and by how much. The Fed says it will be leaving the overnight money rate untouched through at least 2022. It will presumably be slowing down its unconventional liquidity injections sooner than that. A strong economy, which on balance would likely be a good thing for stocks, probably means the 10-year Treasury rises from the current 1.50% – 1.60% to 2.00% by yearend and to 2.5% sometime next year. My guess is that this is enough to slow the stock market’s advance but not derail it. This is because many stocks will have the offset of strong earnings growth. Clearly bad for bonds, though.

inflation. I have a very conventional view. In advanced economies, inflation is a function of wage growth. It’s also a question of creating in consumers’ minds the ( economically bad) conviction that prices are going to continue rising at an accelerating rate, a belief the Fed has been at pains to stamp out over most of the past half-century. So, I think that despite recent press hysteria, inflation isn’t a major problem right now for us as investors.

Deflation, a condition we’re arguably still flirting with, is a far more serious potential risk. It’s a serious issue, as the 1930s demonstrated, because financial/operating leverage become killers when prices are falling. It’s a problem for no other reason than we’ve been living next door to zero for a long while now and the Fed has been trying to create inflation, for years, without success.

–reopening.

I think this is the most important consideration for the stock market. That’s at least partly because I think the was reopening will play out isn’t clear. Two aspects:

–there will likely be a sharp differentiation between stay-at-home stocks whose strength has been mostly a function of the pandemic, and which will likely fade as reopening develops vs. stocks where the pandemic has created an introduction to consumers who will continue to use the goods/services as part of a new normal. Etsy, Zoom and Peloton are prime examples. I’m thinking the first two are faders and the third isn’t …but I really don’t have a high level of conviction. Overall earnings growth momentum, however, will likely be lower than

–I think there’ll also be a similar differentiation among stocks hurt badly by the pandemic between those that bounce back sharply as the economy recovers and those that fail to do so. Overall, I think this is a better area to be prospecting in than in pandemic beneficiaries, but I suspect this will also be a story of haves and have-nots. Walmart, for example, is up by about 4% this quarter, while Target has gained 22%. Yes, TGT has a slightly more affluent demographic, but I think this is more about store location and selecting what the consumer perceives as better value for money. I think this will extend to restaurants, travel and entertainment, as well.

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