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So many questions swirl as the calendar turns — including what year has just started.
What year or years from the past, that is, have the most relevance for the current market and economy. Before the objections are uncorked: Of course, there are no exact replays of history, and the key to tomorrow is not lying in a musty archive.
Yet each year contains its own distinct blend of prior patterns which we interpret as cycles and convert into probabilities for future outcomes. There are always rough precedents even for periods that feel wholly unprecedented.
With that in mind, the year 2021 begins as an apparent hybrid of 2010 (early-cycle recovery), 1999 (late-cycle risk binge) and – a far lesser-discussed antecedent – the early-1940s. (There’s another narrative in the air of a Roaring Twenties repeat. That’s a subject for another time but seems as much a wishful hot take as a considered analogy.)
A War Story
Before getting to the more recent historical touchpoints, a word on the World War II market and policy backdrop to illuminate the market’s powerful run amid the awful global experience under the coronavirus.
During the war, as the government ran record deficits to finance the military effort, the Fed and the Treasury set government-bond yields from short- to long-term maturities at low levels, to promote demand for record amounts of debt and keep the yield curve positively sloped. Today’s is not quite doing the same, but its promise to keep short rates at zero and buy bonds unless and until full employment and higher inflation are achieved is serving a similar purpose.
And then there’s the market’s behavior. The U.S. had little military success in the first months after entering the war. All knew it was going to be a dauntingly long, uncertain and painful ordeal. Yet as soon as the U.S. had its first military success in the Pacific in 1942, the market bottomed decisively and ran almost straight up – even as the bulk of the war and casualties and expense lay ahead.
One can imagine the equivalent of bloggers and tweeters at the time noting with alarm that Wall Street appeared alarmingly out of touch with the realities on the ground, as we’ve heard since March 2020.
Echoes of 2010
The main resemblance to 2010 comes in the market action itself. A powerful upside reversal from a panicked sell-off in March followed by an uncommonly broad and persistent rally that for months investors treated as fragile, premature or misguided.
Nicholas Colas, co-founder of DataTrek Research, notes: “Like the March 9, 2009, lows for US stocks, the March 23 lows [in 2020] marked ‘peak unreliability’ in terms of investors’ judgements about their environment. In both cases, fiscal and monetary policy went to work to reestablish market confidence.”
Plenty of Wall Street handicappers have been noting the synchronicity between the 2020 equity advance and those of 2009 – and, for good measure – the decisive rally in 1982 that launched the greatest-ever bull market.
There are also macroeconomic echoes. The typical early-cycle swing higher from deeply negative manufacturing indexes, corporate earnings and consumer confidence, for example.
The overwhelming central-bank and fiscal responses are similar in effect. In each case, the Federal Reserve’s actions (quantitative easing then, a promise of heavy accommodation until explicit inflation targets are reached now) were novel and generated awe.
Arguably the Fed’s stance and message now is more supportive for asset markets than in 2010. Early in 2010, the Fed ended QE1 and at the time investors assumed rates would “normalize” fairly soon. As the above chart shows, the market turned choppy and corrected early in 2010 as it digested the massive ramp off the lows.
Is the Fed’s current “zero rates for years” position more believable and durable?
Liquidity, after all, is not a quantity of a substance called money, not the nominal size of the Fed’s balance sheet or bank reserves; liquidity is a promise believed. In this case the promise of easy conditions until unemployment falls a lot and inflation surpasses 2% for a while. Perhaps investors’ belief in this promise will be tested, if the economy and markets start to run a good deal hotter?
Other ways that today differs from 2010 argue against assuming a clean replay. The 2020 downturn, unlike 2007-2009, was not a grinding 18-month reckoning that cost the stock market half its value, threatened the financial system itself and wrung out years of dangerous imbalances in the credit markets and household finances.
It was a mandated shutdown, a flash recession, with a quick fear-driven market collapse halted by enormous, proactive policy measures and left the aggregate consumer balance sheet in good shape, with spending holding up and more than $1 trillion in additional savings.
The 2009 rally took the S&P 500 back up to levels first reached almost 12 years earlier, while the 2020 rebound led to new record highs within a few months. Credit spreads improved tremendously by the end of 2009, but were still far above peak pre-crisis levels. Today credit conditions are even stronger than before the Covid shock, leaving less room for more improvement there to bolster equity valuations further.
And as for valuations…
’99 on the mind
In recent months investment pros have not been able to resist comparisons with the fevered market run-up of the late-’90s, which culminated in a vertical melt-up in tech stocks that capped the indexes for more than a dozen years. Understandably.
Today’s price/earnings ratio on the S&P 500 of more than 22 is the highest since 2000, though a bit below the peak P/E of nearly 26 then. Yes, bond yields are far lower today, and Fed Chair Jerome Powell cited this fact to say equities were not worrisomely overvalued now.
But while lower yields explain higher valuations they don’t boost forward asset returns, and 22-times earnings is likely not a great starting point for delectable long-term gains from here, such as the 18-percent total return the S&P has delivered since March 9, 2009. Unless – and this is not impossible – the old investment math is under revision.
The atmospherics are what have the bubble-callers exercised about 1999 similarities. The rush of IPOs that surge in price, the stampede of newer smartphone investors who chase price and ignore traditional valuation, the entry of Tesla into the S&P 500 in a way that evokes Yahoo’s inclusion in late-1999.
Ark Innovation ETF can stand in for the Janus 20 fund in the late-’90s – a concentrated portfolio perfectly tuned to the technology advances and market themes of the time, spinning great performance to massive inflows which drive its stocks up even more, for as long as it lasts.
Most of the action is rhyming with the 1999 tune but has not run for as long, grown quite as extreme or become quite as pervasive. Non-tech growth stocks now are not as expensive as then. And this market has shown a knack for deflating some of the wilder sub-sectors while the broader market stays supported.
The late ’90s also were discounting the genuinely massive promise of new technologies and turned tech from a sector that always traded at a discount (due to cyclicality) to one valued at a persistent premium. In other words, much of the excitement was well-grounded but was carried to indiscriminate extremes. And even then the fun didn’t end until the Fed began tightening aggressively in 2000.
The upshot: 2021 is serving investors a cocktail of early-cycle recovery forces and policy inputs, with late-cycle valuation and risk appetites. It could well provide a kick.
