Since 1833, the Dow Jones industrial average has gained an average of 10.4% in the year before a presidential election, and nearly 6%, on average, in the election year. By contrast, the first and second years of a president’s term see average gains of 2.5% and 4.2%, respectively. A notable recent exception to decent election-year returns: 2008, when the Dow sank nearly 34%. (Returns are based on price only and exclude dividends.

 

 

The one thing markets do seem to prefer – “political gridlock.”

A split Congress historically has been better for stocks, which tend to like that one party doesn’t have too much sway. Stocks gained close to 30% in 1985, 2013 and 2019, all under a split Congress, according to LPL Financial. The average S&P 500 gain with a divided Congress was 17.2% while GDP growth averaged 2.8%.

 

 

Outcomes are overly dependent on many things continuing to go “right.”

  1. Avoidance of a “double-dip” recession.(Without more Fiscal stimulus, this is a plausible risk.)
  2. The Fed continues expanding monetary policy.(There is currently no indication of this.)
  3. The consumer will need to expand their current debt-driven consumption.(This is a risk without more fiscal stimulus or sustainable economic growth.)
  4. There is a marked improvement in both corporate earnings and profitability.(This will likely be the case as mass layoffs will benefit bottom-line profitability. However, top-line sales remain at risk due to items #1 and #3.)
  5. A sharp improvement in employment, rising wages, and falling jobless claims will signal a sustainable economic recovery.(There is currently little indication this is the case outside the bounce from the March shutdown.)

 

US Economy

 

  • The August CPI report was slightly above market expectations.
  • Used car prices jumped sharply, as Americans move to less-populated areas and avoid public transportation. Vehicle repair costs are higher.
  • These are challenging times for formal work attire retailers since many no longer go to the office. Men’s suits, Women’s Suits, Dry Cleaning services, have suffered.
  • Fast food restaurants have been boosting prices, as they face higher expenses.
  • US renters increasingly face evictions, and without further government support, the situation may worsen in the months ahead. As of early September, substantially fewer renters have made payments vs. last year.
  • Google search activity related to evictions is soaring.
  • Industrial production growth eased last month,
  • Capacity utilization remains well below pre-crisis levels.
  • The NY Fed’s regional manufacturing index showed an improvement in factory activity this month.
  • New orders are growing again.
  • Employment is strengthening.
  • CapEx expectations improved.
  • Deutsche Bank expects food CPI to moderate.
  • The PPI for healthcare services is picking up, which could be a tailwind for PCE inflation.
  • The US dollar weakness is putting upward pressure on import prices.
  • Without another CARES package, incomes will come under pressure.
  • Credit and debit card spending in Pacific states is lagging the rest of the country.
  • The August retail sales report was softer than expected, suggesting that consumption recovery is losing momentum.
  • There is little doubt that the recovery in retail sales has been driven by enhanced unemployment benefits.
  • The US inventories-to-sales ratio continues to decline.
  • Initial jobless claims fell last week but held above one million new applications.
  • The total number of Americans receiving unemployment benefits remains stubbornly high.
  • Permanent business closures continue to climb.

 

 

  • The $44 billion currently allocated for enhanced unemployment payments ($300/week) is expected to run out this month.
  • The number of ‘zombie’ companies is approaching the 2000 peak.

 

Cares Act 2

 

Analysts are starting to have doubts about a CARES 2 stimulus package this year. Here are the aggregate probabilities.

 

 

The concern is that cutting off the stimulus checks could reverse the recent economic gains. At this point, the recovery is already slowing, making it vulnerable to a shock.

 

 

 

The Fed

 

Asset growth has slowed.

 

 

“Velocity of money” is the rate at which money changes hands. Rising velocity is typically associated with economic growth and inflation. Falling velocity may signal deflation and economic contraction. That is what we see right now. Velocity has actually been falling for some time but fell off a cliff in 2020. This will, among other things, complicate the Fed’s desire to generate 2% average inflation.

 

 

Following its two-day policy meeting, the Federal Reserve indicated that, provided inflation is not excessive (over 2%), it expects to keep interest rates near zero through 2023 until it hits “maximum” employment. Additionally, the Fed revised its GDP estimate to be 3.7% below its year-earlier level in the fourth quarter as opposed to 6.5% lower. They also now estimate the unemployment rate averaging 7.6% in 4Q, rather than 9.3%. Analysts believe that the Fed has set a high bar for raising rates in the future.

 

Current Market Valuation and Forward Returns

 

Here, I’m sharing one of my favorite coming return charts. It looks at the overall size of the stock market as measured by the S&P 500 Index and compares it to U.S. Gross Domestic Income.

Here is how you read the chart:

  • The very bottom section plots the Stock Market Cap as a percentage of Gross Domestic Income (how much we collectively make). Focus on the blue line
  • When the blue line is above the dotted back line, the market is in the “Top Quintile – Overvalued” zone
  • When the blue line is below the bottom black dotted line, the market is in the “Bottom Quintile – Undervalued” zone
  • We currently sit in the overvalued zone
  • The red arrows point to the subsequent 1-, 3-, 5-, 7-, 9- and 11-year subsequent returns. IMPORTANT: Returns are not annualized
  • The picture that is being painted is that in past periods when the market was overvalued, subsequent actual returns we negative in the following 1 to 11 years as noted
  • Bottom line: Expect zero to slightly negative returns over the coming 9 years and a flat return over the coming 11 years for Buy and Hold strategies. Negative to zero progress.

 

 

Last comment on the above slide. More defense today provides the ability to take advantage of the return opportunity that will present in the “Undervalued” zone. Doesn’t mean you have to lose money. Also note the buying opportunity in 2009.

S&P 500 10-year Returns Based on Shiller P/E (10-Year Earnings):

Let’s look at the Shiller price-to-earnings (P/E) ratio. It currently reads 30.69 as of Friday, September 18, 2020. You can see the 1929 level, 1966 (bull market top), and 2000 tech bubble top. Look how low it got in 2009.

 

 

Valuations provide us with the opportunity to look back at history and see what kind of return we earned on our money based on P/E valuation starting conditions. This data set is pretty cool.

Here’s how to read the chart:

  • The yellow highlight is where we sit today, in the “Most Expensive 20%” of occurrences since 1881
  • The lowest 10-year subsequent return achieved when in the most expensive zone was -6% annually for 10 years
  • The highest 10-year subsequent return achieved when in the most expensive zone was +10% annually for 10 years
  • The median 10-year subsequent return achieved when in the most expensive zone was +3.5% annually for 10 years (I think this is a reasonable expectation)
  • The yellow box also highlights a range of +5% to -1% annually. I believe we end up somewhere between those return numbers

 

 

Here is another look at the data, but after inflation is calculated:

  • Note, we should get more aggressive in the left three valuations zones… Big market declines create great forward return opportunities

 

 

Barclays says valuations at dot-com bubble levels, downgrades large tech stocks

https://www.cnbc.com/2020/09/18/barclays-says-market-valuations-at-dotcom-bubble-levels-downgrades-large-tech-stocks.html

 

The Challenge of Valuing Gold

 

With the Federal Reserve signaling it will accept higher inflation, many investors are looking to gold. Consider how gold looks against various other assets.

Key Points:

  • As a “scarcity asset,” assessing gold’s fair value is challenging. Its value comes not from its utility or cash flows, but simply because it is rare.
  • This valuation difficulty may explain why gold is an unpopular asset class among institutional investors.
  • Gold is reasonably valued against inflation, expensive relative to US wages, US real estate, oil, silver, and non-US equities, and cheap compared to US long bonds and the S&P 500.
  • In other words, gold as money looks overvalued; gold as commodity looks expensive; and gold as a financial asset has room to run.

We believe gold will move higher until either the US dollar strengthens meaningfully or the Fed tightens policy. Neither is likely right now, so expect the gold bull market to continue.

 

Interesting

 

Who owns US government debt?

 

 

Daily pollution levels:

 

 

Kids Coming Home

We saw in 2008 and again in 2020 how recessions raise the number of young adults living with their parents. The jump was particularly notable this year, with the Pew Research Center noting the percentage now matches Great Depression-era levels. But it turns out the trend goes way back, rising since 1960 according to census data.

 

 

Moreover, that 1940 peak was itself the high point of a similar trend dating back to 1910. So in long-term perspective, the oddity is how many young adults moved away from their parents in the 1940s and 1950s. Multigenerational living isn’t as historically unusual as some Boomer and Gen-X parents think. They might want to consider it in estate planning, real estate, and investment strategy decisions.