Market & Economy
By Tim Doyle, Chief Investment Officer, CFP®, MBA
As a Colorado resident of nearly 20 years, I have come to expect, and at times appreciate, the weather-related “head fakes” that occur so often at this time of year. Each winter in the depths of February and March, we get a few beautiful 55 degree days, and I begin to daydream about planting a garden, golf outings and putting around town on my pitiful little 49cc scooter. I then wake up the next morning and find myself tempestuously scraping seven inches of unexpected snow off of my car before I drape two little boys in 37 layers of clothes as we embark on our daily trek to daycare.
After a solid start to the month of February, we've seen markets pull back with the S&P 500 (Technology and Consumer Discretionary stocks, in particular) selling-off in recent trading days. Much like late-winter weather in Colorado, we must ask ourselves whether or not this is just a short-term “head fake” or if markets are in store for a more significant, longer-lasting change in temperature.
To address this, we'll look at a few key issues that may affect the trajectory of stock markets as we move into spring and summer, including updates on the COVID-19 pandemic, COVID-19 stimulus efforts and the Q4 2020 earnings season.
After having our first child, my wife and I slowly came to the realization that we simply could no longer visualize our pre-child life together. Was there ever a time when we didn't have an unceasing stewardship over a helpless, little life? What did we do with all of our spare time on weekends? Did we really go to all of those dinners and concerts together? What the heck is a nap?
The World Health Organization (WHO) officially declared COVID-19 a global pandemic in March of 2020. We are roughly one full year into this tragic ordeal and much like life with a young child, it is becoming more and more difficult to comprehend a pre-COVID existence. It is hard to fathom a time when any of us could sit and laugh in a crowded restaurant, attend a sporting event, host a backyard barbecue with friends and family, visit a museum or casually walk through any public space without a mask.
Over the weekend, I watched a replay of one of my all-time favorite shows, Anthony Bourdain's Parts Unknown. I watched with acute nostalgia as the late Bourdain and renowned chef Daniel Boulud visited Lyon, France, touring the countryside, dining in crowded restaurants and drinking wine as they made charcuterie with fellow chefs. That carefree lifestyle felt so alluring and familiar, yet so distant.
It is difficult to focus on the positives in a month that total COVID-related deaths exceeded 500,000 in the United States and 2.5 million worldwide. Still - variants notwithstanding - we appear to be finally turning a corner in our battle against this terrible, life-changing virus. As illustrated in the chart below, we have seen daily confirmed new cases fall precipitously in the United States in recent weeks.
Over 44 million Americans have received at least a single dose of either the Pfizer or Moderna vaccine, and it is expected that the vaccination rate will increase dramatically throughout the month of March. As of this writing, it's also been announced that Johnson & Johnson's single-dose vaccine will receive the FDA's emergency use authorization. This will only aid our country's vaccination efforts, leading medical experts to believe that any citizen who wants a COVID-19 vaccine, will get a COVID-19 vaccine by July of 2021.
This is all very positive news not only for every American citizen, but for both the economy and financial markets. However, as we have said many times before, true recovery won't be based on what people can do as restrictions are lifted across the country, it will be based on what people will do while a significant threat of contracting COVID-19 still remains. All indications are that the pandemic will remain a threat throughout the coming months, which is why additional fiscal stimulus is under consideration, which I will review in the next section.
The American Rescue Plan
Democrats and Republicans are in a heated debate over the $1.9 trillion stimulus package proposed by the new Biden administration. While the final product will undoubtedly look somewhat different after negotiations, we expect additional stimulus to be passed in March to continue to bridge the gap from pandemic to recovery.
Knowing that this is an evolving situation, I will provide a high level summary of what's being proposed in the American Rescue Plan package. It's important to note that none of these proposals have been approved for implementation as of this writing:
Unemployment Benefits: enhanced unemployment benefits are on track to expire by March 14, 2021. The new package would extend these benefits through August 29, 2021 and would increase the additional weekly benefit from $300 to $400.
Stimulus Checks: $1,400 checks would be delivered for individuals making $75,000 or less, or for married couples filing jointly with income below $150,000. There are phase-outs for individuals/married couples with incomes in excess of $75k/$150k. Adult dependents and children (such as college students) would also be eligible for $1,400.
for children under 6, the new maximum credit would be increased from $2,000 to $3,600
for children ages 6 to 17, the credit would increase from $2,000 to $3,000
the full amount would be refundable and not subject to an income-based phase-in.
Earned Income Tax Credit: the plan would expand the Earned Income Tax Credit (EITC) for workers without children from $530 to roughly $1,500, and it would also raise the income limit for this credit from $16k to $21k. This change would only apply to the 2021 tax year.
Expanded Child & Dependent Care Tax Credit: this would expand the current credit to cover up to 50% of child care expenses up to $4k for one child, and up to $8k for two or more children in 2021. This credit would be fully available for families making $125k or less, with phase-outs for those earning $125k-$400k. Current law allows for a credit up to 35% of $3,000 for a single child or 35% of $6,000 for two or more children.
State & Local Aid: the plan includes $350 billion in flexible aid for state and local governments. The plan also proposes $20 billion to support local transit and $20 billion for tribal governments.
Pandemic-Specific Aid: there is an additional $160 billion proposed for vaccine distribution, expansion of testing and general support of vaccine supplies.
Rental Assistance: $30 billion would be allocated to renters and small landlords.
Education Assistance: $170 billion would be allocated to support school reopening efforts and $25 billion in support of child care providers.
Supplemental Nutrition Assistance Program (SNAP): a 15% benefit increase for the SNAP program passed in December would be extended from June to September of 2021.
Expanded Family and Paid Sick Leave: the ARP would strengthen paid sick and/or family medical leave for workers required to quarantine, care for family members sick with COVID-19 or care for children due to school closures. This expanded leave would include a maximum paid leave benefit of $1,400 per week with full wage replacement up to $73,000 per year.
Clearly, this stimulus proposal is significant, but before we discuss potential ramifications for investors, it is important to understand where we stand now as we approach the end of the latest earnings season.
As of this writing, 84% of S&P 500 companies have reported Q4 2020 results, with 79% of these companies reporting a positive earnings surprise. This earnings surprise percentage (assuming it holds) would be the third highest rate since 2008. The magnitude of the earnings surprise is also considerable, with companies reporting earnings that are 14.6% above consensus estimates versus a five year average of 6.3%.
Leading the way was the Consumer Discretionary sector, which reported the largest aggregate difference between actual versus estimated earnings (+45.3%). In fact, within the Consumer Discretionary sector, Amazon reported one of the largest positive actual versus estimated EPS surprises of $14.09 versus $7.20.
Energy (+26,7%), Financials (+25.8%), Communications Services (+25.6%) and Information Technology (+16.1%) round out the top EPS performers.
The biggest laggard was the Industrials sector (-25.7%), where Boeing reported the largest negative actual versus estimated EPS surprise of -$15.25 versus -1.78.
When it comes to revenues, 77% of companies have exceeded revenue projections. In aggregate, reported revenues are 3.2% higher than estimates versus a five year average of 0.9%.
What Does This Mean For Investors?
Generally speaking, earnings season has delivered encouraging news for financial markets, given the somewhat bleak expectations. However, moving forward, analysts are projecting double-digit earnings growth for each quarter of 2021 as optimism abounds and economic conditions improve. Simply put - expectations will be higher.
As we have stated many times, we believe that 2021 may ultimately be seen as The Year of the Recovery, as a confluence of pent-up demand and aggressive stimulus heat up the economy in Q2 and Q3 of 2021. News about vaccine distribution and efficacy along with eventual fiscal stimulus could send stocks higher in the short term.
However, investors must remain cautious, given the fact that stocks remain somewhat expensive, as illustrated below, with the forward P/E of the S&P 500 hovering at 21.85x versus a 25-year average of 16.61x.
We also must remember that stock markets are forward-looking, so current prices are set in anticipation of stronger earnings in the quarters ahead. We may see investors grow more cautious over the late summer months as pent-up demand stabilizes, the stimulus sugar-high fades and shareholders begin to ask what comes next. We could also see inflationary pressures and higher interest rates, which may cause new challenges for stock owners and bond holders in the years ahead. What a buzz kill, right? This is why I don't get invited to many parties, even before COVID-19.
The Bottom Line
The bottom line is that we have been talking about a light at the end of the tunnel for nearly a year now, and we are finally approaching a time when we may begin to reconnect with family and friends and renew hobbies and passions that have been put on hold due to this pandemic. That alone is worth celebrating and appreciating. We will savor any positive changes that each day brings, and we will navigate any future challenges as we have throughout this crisis with patience, discipline and decisions that are driven by knowledge and data, not fear.
Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.