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Paradox of Highs!

Last month fo 2020 started with Paradox of highs! Here is why I consider it as Paradox:

COVID:

  • US daily COVID infections are at all time highs (above 225,000)
  • US daily COVID related death rates are all time high (above 2500)
  • US hospitalizations is over 100,000 - in some regions ICU capacity reaching 85%
  • Many regions are announcing "shelter-at-home" (aka lockdowns) phase
  • Europe is also seeing high number of infections and deaths
  • Asian nations which handled virus quite well (South Korea, Japan) are also seeing increased infections
  • In summary - third wave seems to be lot worse than first two waves and going to get worse before it gets better due to winter and holiday gatherings
Markets:
  • All 4 indexes (DOW, S&P, Nasdaq and Russell 2000) reached all time highs on Friday - last time it happened was in 2018
  • Markets across the world are making new highs 
  • Bitcoin reached all time high; Gold is very close to all time high
  • Even 10 year treasury yield reached 1% (pandemic high)
  • US Housing prices are at all time highs
  • Cloud companies are selling at triple digit price-to-sales (Snowflake at over 100 P/S ratio)
One would have expected markets to go down significantly given grim news on virus front. But exactly opposite is happening. That's why I consider this as "Paradox of Highs". Let's look at reasons for this Paradox. I had covered some of these in my blog "Markets V Factors"
  • Vaccine - UK became first western country to approve first COVID vaccine. US will follow it next week. With two effective vaccines (from Pfizer/BioNtex and Moderna), US could vaccinate 20 million people before 2020 is over. That would be record by any standard in terms of new vaccine approval and rollout. By Spring, we could see 1/3rd of US population getting vaccinated.
  • Employment - November report showed that employment slowed down from over 660,000 to 245,000. That's bad news for economy. But markets treated this bad news as "good" news because now politicians must act on stimulus front
  • US Stimulus - Finally politicians from both parties started talking about a reasonable compromise on immediate stimulus plan around $1 Trillion. It could come as early as middle of Dec - just in time for holidays. This would be followed by another one in Feb/March after Biden takes charge.
  • Interest Rates - FED is committed to maintain very low interest rates and accommodative fiscal policies well into 2022/2023.
  • Earnings - Q3 results came out strong with very few dis-appointments. Corporates are holding record cash (over $2.1 Trillion). That money is going towards buybacks and acquisitions (Salesforce/Slack, S&P/IHS)
  • Economy - two biggest economies (US and China) recovered much faster than expected and would reach pre-pandemic levels in 2021
  • P/E expansion - Markets are willing to pay higher multiple for each $ of earnings. e.g. in 2013, S&P  P/E was 13; in 2017 it was 17 and in 2021 it would be 21. So while earnings may not be expanding as fast, due to P/E expansion, markets continue to make new highs. This may be due to lack of alternatives for money to be invested (given that 10 year yield has gone down from 3% to 2% to under .5 this year)
Given these data-points, it is possible that this "Paradox of Highs" would continue till normalcy returns in 2H2021. As fas as investing is concerned, I would recommend mixing ETF of dividend paying value stocks (XLE/XLF) as well as reasonably priced growth stocks (XLK/CLOU). So my earlier recommendation of "ETF" still holds even if energy and financials have gone up by 20-30% in last few weeks

/Shyam
 


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