Post Election & Vaccine Update
Cambiar President Brian Barish discusses what the election results and news of a potential COVID vaccine could mean to equity markets.
Now that the elections are behind us, what does it mean for equity markets?
There’s an expression that equity markets hate uncertainty more than anything else, and elections, when they’re over with, no matter who wins, there is less uncertainty. So they tend to rally a bit immediately following elections, and so far that’s proving to be the case.
Secondly, in the 2020 election, you had vast voter turnout and that resulted in a split government, with neither party holding a clear advantage. Now that might on a long-term basis raise some questions, but on a short-term basis, it also means certainty. There’s nothing terribly controversial that is going to be legislated. It’ll just be too difficult to do, and that’s also good for stock markets. Now, there is an offset to all this, which is that we are entering 2021 at very high valuations by historical standards. So the S&P 500, as we speak, is trading for about 27 times trailing earnings. The NASDAQ is closer to 70 times trailing earnings. If you back out negative earnings and you assume that there is a good earnings recovery in a lot of businesses, the S&P 500 is more like 21 times forward earnings, and the NASDAQ more like about 30 times forward earnings. Those are still not cheap. So that does beg a very real question of whether stock markets have discounted much of the good already.
What will the news of a potential vaccine mean for markets?
Just recently, the first successful COVID vaccine trial was announced. This is hopefully the beginning of a powerful series of changes in the composition of the stock market. For most of 2020, the market has been very split between companies that are digital economy businesses that are not really affected by the pandemic appreciably and alternatively companies that are more physical economy-related, which have been to varying degrees extremely affected and very negatively by the pandemic. So our hypothesis is that you will see much better earnings growth off of arguably very depressed levels for physical economy type of businesses. We suspect two things, that you will have a lot of pent up demand for CAPEX, a lot of that has been deferred this year, and you should see a fairly robust CAPEX cycle in 2021 and beyond. And for consumers, for things like business travel and other forms of affordable luxuries and discretionary items, also a lot of pent-up demand.
What are some of the long-term realities as we head into 2021?
One of the biggest ones is debt and interest rates. What is the right interest rate in terms of an equilibrium in the United States? Can the Fed and other central banks really induce inflationary conditions, which they claim to want to do? What distortions to the economic reality are being caused by all of this?
So if you look at a long-term picture of total debt in the economy, what you’ll notice is that you need more and more debt to achieve an incremental unit of GDP. Over the course of time, through the high inflation period in the ’60s and ’70s, through disinflation in the ’80s and ’90s, and through what’s been a very low inflation period in the 21st century, you’ve seen this ratio become more and more unfavorable.
In other words, the debt is becoming much less productive. We think there’s a lot of causes associated with this. It’s not a political issue. It’s a function of where we are in the history of the world, and that we are very much entering the digital age, where we don’t need as many physical assets to achieve productivity gains, and as a result of that, the incremental efficiency of debt is challenged. That has some really powerful implications for asset allocation and whether or not central banks like the Fed are able to truly achieve inflationary goals by pushing on the cost of debt.
Our hypothesis is that we’ll see some increase in interest rates over the course of 2021 due to cyclical factors. Arguably the economy is still very depressed from what it’s capable of doing if everybody was able to walk around and interact normally, but that the realistic high point of interest rates remains very, very low, and that the economy would have a good deal of trouble if you got interest rates much above the 2% level.
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