The past week has been one of the strangest weeks that we have encountered in a long time. In our previous commentary we discussed ‘potential’ bubbles in Tesla, Bitcoin, and non-profitable Technology companies. There have been extreme moves in all of these areas and 2020 was especially noteworthy for non-profitable Tech companies as seen in the chart below.

It probably makes sense to add Game Stop to the list of ‘potential’ bubbles because we now have retail investors short squeezing hedge funds via Reddit. But who’s David and who is Goliath?

Despite an intra-day drop of 70% yesterday, GameStop is still up nearly 900% this year. In a span of a few weeks, GameStop went from a small cap stock to a mid cap then a large cap stock. At one point it was large enough to be around number 260 in the S&P 500. It seems like speculation to us, but please don’t take our word for it because we’re not experts in the gaming sector.

So while we do see some froth in certain parts of the market, that’s not where we are investing our clients’ money so it’s somebody else’s issue to deal with. What this week does show is the magnitude of the firepower that the US retail investor has. Consumer wallets have swelled due to the stimulus and there is more on the way according to what we have heard from President Joe Biden.

Over the last 10 months, there has been a very strong advance in global equity markets as measured by the MSCI World Index, which is up nearly 70% since bottoming in late March. Valuations are currently at the upper end of the range on certain metrics such as the price-to-earnings ratio. Furthermore, investor sentiment measures appear elevated and would imply that investors have become complacent. All of this suggests to us that the market is ripe for some consolidation and we did see a bit of that this week when the S&P 500 declined by 2.5% on Wednesday. Corrections are normal and they happen almost every year, even during bull markets. As seen in the chart below, the average annual drawdown over the last 30 years has been 14.2%.

Nobody knows when these drawdowns will occur nor do we know how severe they will be. The important takeaway from this chart is that even though there have been drawdowns of 7% or more in 24 of the last 31 years, the S&P 500 has only experienced a negative annual return in only 9 of those 31 years. And in 2 of those years (2011 and 2015), the market was down by less than 1% so essentially flat. The point is that market drawdowns have typically been good buying opportunities. Not always, but most of the time.

So, what about today’s situation? We believe that a drawdown in 2021 will likely represent a good buying opportunity because we continue to expect a global economic recovery. There are several tailwinds that will support the recovery including government stimulus measures, low interest rates, and a huge amount of pent-up demand from consumers. In addition, Q4 corporate earnings have been strong thus far and have led to earnings upgrades from analysts. And finally, financial conditions remain loose. According to the Federal Reserve Bank of St. Louis, (https://fred.stlouisfed.org/series/NFCI), the current reading of the Financial Conditions Index is near its lowest level of the last 20 years. This implies that there are few signs of stress within the financial markets. Putting it all together, we continue to have a cautiously optimistic outlook for 2021.

Have a good weekend,

Phil