February 26, 2021
Thank you for your interest in Gallacher Capital Management’s recent market outlook call with David Bianco, Chief Equity Strategist with DWS. Here is a summary of the items discussed during the call:
The S&P has experienced a historic comeback from the selloff last March despite the pandemic. The challenges facing the economy remind us that the stock market is not an accurate representation of the economy as a whole. How has the S&P 500 been so resilient? David lists three major reasons:
Big Tech – Big tech has experienced record earnings as these firms helped provide the tools for our economy and businesses to continue to function during the pandemic. Given that Technology represents a significant portion of the S&P 500, these stocks have been driving the returns of the index. Low Interest Rates – The Federal Reserve, between purchasing bonds on the open market, and lowering the Federal Funds rate to near zero has allowed Price to Earnings (P/E) ratios to expand beyond their historical averages. Economic recovery – supported by government stimulus as a stop-gap and vaccines coming to market ahead of schedule, the economy is recovering and there is light at the end of the tunnel. This rally, however, has significantly changed the way the US market is composed. The S&P 500, widely considered a balanced benchmark for the broad stock market, has morphed into an index that no longer represents the whole. Nearly 45% of the index today resides in technology, communication services, internet retailing and Tesla (TSLA) – making it much more growth heavy than in the past. Many investors don’t realize they are concentrated in this way when they purchase the S&P or invest in strategies that are closely tied to it. As such, David recommends a theme for 2021 should be to employ diversification, specifically to counterbalance growth and big tech exposure. Healthcare is poised to perform well and investors should also look overseas in areas such as Europe and Japan for attractive value plays across industrials, autos, and capital goods.
The stimulus from the government in response to the pandemic has been massive, now approaching $4T and comparable to government spending during World War II. This has certainly helped to offset the devastating impacts from economic shutdowns but the question remains – how do we pay for it? The current administration’s belief is to “spend now, tax later.” However, tax hikes may come sooner if the bond market becomes spooked by increasing levels of national debt. David believes the ultimate result of the stimulus will be modest-to-moderately higher inflation, increasing real interest rates, and higher taxes.
The Federal Reserve is expected to remain accommodative by keeping interest rates low and increasing the money supply by purchasing newly issued government debt. Over the past decade, this has not resulted in much inflation as these additional dollars have mostly sat on bank balance sheets. However, if the increased money supply finds its way into circulation through loan growth, inflation may begin to accelerate, although this dynamic would likely play out slowly. David does not expect inflation to rise like the 70s, but thinks it’s important to have some protection within a portfolio. Equities should provide this over the long term, assuming companies are able to re-price their goods and services. And while commodities have been a decent inflation hedge in the past, they may not perform as well given the US is a more service based economy today.
Looking ahead, David anticipates the economic recovery to continue, but emphasized it will take time for unemployment to come down along with savings rates as consumers adjust their spending habits back to normal. The economy continues to struggle on the service side and David does not expect the Fed to raise short term rates until 2023. Some areas of the market have potentially gotten ahead of themselves in pricing in a recovery such as hotels and consumer discretionary, thereby creating opportunity in defensive areas such as consumer staples. He also mentioned that electric utilities should be a beneficiary of the move towards electric vehicles. And if interest rates continue to grind higher and the yield curve steepens, banks should benefit from higher net interest margins.
We appreciate David taking the time to share with us his thoughts on the market and outlook for 2021. We hope you found it useful and are happy to answer any questions you might have.