A disciplined approach to investing blog
In a post I wrote in late January I noted the headwind that an increased regulatory and tax burden is likely to have on economic growth. Last week's jobs reports provided further evidence that a slower economic environment may be taking hold. As the below chart shows, the level of employment seems to be trending sideways and is approaching the trajectory of the slow job recovery following the financial crisis in 2008/2009.
At the end of November last year I highlighted the fact the most shorted stocks had started to gain momentum at the beginning of October. Fast forward to the start of February and Refinitiv's U.S. Most Shorted Stock Index has continued to generate outsized gains. For the last four months the Refinitiv U.S. Most Shorted Index is up 92.8% versus 10.4% for the S&P 500 Index. Half of this gain has occurred in January with the Shorted Index up 40% as seen in the second chart below.
Last week investors were reintroduced to the terminology of 'short squeeze' and 'gamma squeeze'. It has been some time since the phrase gamma squeeze was bantered about as much as it was last week as the volatility in a few stocks captured headlines. Stocks like GameStop (GME) and the movie chain AMC Holdings (AMC) saw their stock prices swing widely, but mostly to the upside. So what is going on with a few stocks like this.
S&P Dow Jones Indices announced the results of its annual rebalancing of the S&P 500 Dividend Index. Three companies are being added in this rebalancing and three are being removed, leaving the number of Dividend Aristocrats at 65. The changes go into effect prior to the market open on February 1, 2021. As noted by S&P, "S&P 500® Dividend Aristocrats® measure the performance of S&P 500® companies that have increased dividends every year for the last 25 consecutive years. The Index treats each constituent as a distinct investment opportunity without regard to its size by equally weighting each company." In addition to the dividend increase requirement, other factors S&P Dow Jones Indices includes in the methodology to select the dividend aristocrats are:
In our Winter 2020 Investor Letter released earlier this month, our firm indicated our real GDP growth expectation for this year is in the mid single digit percentage range. We continue to hold that view given likely pent-up demand and our expectation the economy is exciting the recession. The uncertainty around the virus spread and vaccination progress is a headwind to our growth expectation though. Additionally, before the inauguration of President Biden on January 20, I highlighted the potential risk of a policy error to the economic recovery. Some of the executive orders (EO) signed by the President after he was sworn into office on January 20 now heighten this risk in my view. For investors it is important to separate their political/policy concerns with the view of the performance of the investment markets.
The broadening in performance across multiple equity asset classes is providing investors with investment opportunities outside of the S&P 500 Index. The S&P 500 Index has certainly been a stalwart in terms of performance over the last five and ten years. Given the strength in the equity market and the index trading at valuation levels that some call stretched, investors might consider dividend paying stocks for a portion of their portfolio. One characteristic of dividend payers is they generally hold up better in down equity markets.
Broadly investors have enjoyed strong returns in stocks over the past two years, the S&P 500 Index returned 31.5% in 2019 and 18.4% in 2020. Last year's return occurred in an environment where earnings for S&P 500 companies is expected to equal $133, down from $157 in 2019. This move higher in stocks at the same time earnings declined has pushed large company stock valuations to levels where one might say they are priced for perfection. One way to look at stock valuations is reviewing a measure called the Rule of 20 which states that stocks are fairly valued when the inflation rate plus the price earnings ratio of the S&P 500 Index equals 20. As the below chart shows this measure currently equals 23.4. If one uses the P/E based on the index's 2022 earnings, the measure equals approximately 20.4.
The NFIB Small Business Optimism Index turned decidedly negative in December. The index fell 5.5 points to 95.9 and is below the index's long run average of 98. NFIB reported 9 of the 10 index components declined. The survey report notes, "The drop in small business optimism was historically very large...Most of the decline was a result of substantial weakness in the outlook for sales and business conditions in 2021 which brings new Covid threats and the uncertainty about economic policy with a new administration in Washington." Small business owners excepting better business conditions over the next six months came in at minus 16, a 24 point decline from the month earlier and the second largest drop since 1986.
One favorable aspect of the recent equity market performance is the broadening participation of asset classes other than the large cap FANGMA stocks, Facebook (FB), Amazon (AMZN), Netflix (NFLX), Google (GOOGL), Microsoft (MSFT) and Apple (AAPL). As the below chart shows, during the first eight months of 2020, the average return of this basket of stocks significantly outpaced the other asset classes shown on the chart.
S&P Dow Jones Indices' recent report on buyback activity for the third quarter shows buyback activity increasing to $101.79 billion from $88.66 billion in the second quarter. With the economy mostly reopening, at least through Q3 2020, companies reported an improvement in 'as reported earnings,' increasing to $273.2 billion versus $98.5 billion for the first quarter. As the red line in the below chart shows though, buybacks remain far below the fourth quarter 2018 peak of $222.98 billion.
In the blog post I wrote about a year ago commenting on the October 2019 Job Openings and Labor Turnover Survey (JOLTS) I noted the employment market was extremely strong and there were not enough workers to fill job openings. At that time the unemployed workers per job opening ratio was .81. In other words there were more job openings than unemployed. Fast forward one year later to the October 2020 JOLT survey released last week, that ratio now stands at 1.66. Too many potential workers are now out of the labor force.
The NFIB's November Small Business Optimism Index declined 2.6 points to 101.4. As NFIB notes in their report the Index level is at a historically high level with the 47-year average reading equaling 98. Below are a few key findings in the report:
It seems a broad range of equity indices are hitting new all time highs every day and some investors question whether this can continue. The S&P 500 Index closed at an all time high Friday, December 6, bringing its year to date return to 14.5% on a price only basis. In earlier posts I discussed the roller coaster ride of the market as it traversed the coronavirus shutdown and reopening. The S&P 500 Index fell 33.9% from February to March and has bounced higher by 65.3% from the March 23 low. And since the election in early November, the S&P 500 Index is up 12.5% with only one of the five weeks down a fractional .76%.
This week the government released the second estimate of third quarter U.S. GDP at 33.1% growth at an annual rate, unchanged from the earlier advanced estimate. This is a sharp snapback from second quarter's 31.4% contraction. Of course this significant swing is a result of the virus mandated economic shutdown and reopening.
If the performance of Refinitiv's U.S. Most Shorted Stocks Index is any indication, the shorts have been caught off guard since the market has accelerated higher over the last two months. Most of the move began subsequent to the U.S. election. As the below chart shows the Most Shorted Index is up over 30% while the S&P 500 Index is up 7.9%. Investors likely are not surprised by some of the performance contributors over the last month like, Nordstrom (JWN) up 91%, Plug Power (PLUG) up 74%, Macy's (M) up 52%, Carnival (CCL) up 34%, just to name a few of the companies in the Short Index.
The dominant investment theme since the financial crisis in 2008/2009 has been the outperformance of the growth investment style versus the value style, evident in the large, mid and small cap stock space. As the below chart shows, growth has dominated value in large caps since 2008 and has accelerated higher this year.
Based on this week's AAII Sentiment Survey, over the course of one week individual investors are now super bullish. The survey notes bullish investor sentiment jumped 17.9 percentage points to 55.8%. The below chart shows bullish sentiment is above the plus one standard deviation level. From week to week the sentiment readings can be volatile; thus, looking at the 8-period moving average removes some of this volatility. For this week the 8-period moving average of the bullishness reading is 35.7% and far below an extreme.
Yes, there was a presidential election in the U.S. this past week and up until election day on Tuesday, the uncertainty around the election seemed to weigh on the markets. With Joe Biden now leading in the electoral count, some of the uncertainty seems to be behind the market and the S&P 500 Index rallied 7.13% in the week ending 11/6/2020. President Trump and his team is indicating they will challenging some of the ballots counted in swing states so this could lead to some market uncertainty near term.
