- Forecasting is misunderstood by most of the investing public.
- Investors glom onto forecasts, or belief structures, then do not make the appropriate asset allocation changes when the market signals them.
- Forecasting should be looked at as monitoring a set of probabilistic scenarios and adjusting as more information becomes known.
- One of the first pieces of information to adjust to in 2021 will be whether the Senate remains in Republican control or flips to the Democrats.
- Longer term, we know that the shift to sustainability is accelerating, we need to look for growth and value opportunities in that new paradigm.
Each year I write my “futile forecasts” for the coming year. The idea behind “futile” is that most forecasting gets looked at the wrong way. It’s not about getting some number right at the end of the year.
Forecasting is a series of adjustments to scenarios that you are keeping track of and some that you are not. Staying safe and profiting is in the navigation. Do you want a weatherman steering your ship, or a captain?
One of the big factors to adjust for in 2021 will happen this week. The Georgia Senate election determining whether Republicans keep control of the Senate or Democrats take control could have a massive impact on this year’s markets, as well as, the rest of the decade.
Stocks Need Time For Earnings To Catch Prices
Regardless of how the election in Georgia goes, stocks need time to catch up to valuations. The E (earnings) in P/E needs to rise to justify the P (price). The S&P 500 (SPY) (VOO) is significantly overvalued for likely 2021 and 2022 earnings.
Even with ZIRP, valuations would still be second standard deviation, i.e outside the norms and the second or third highest in over a century.
In 2015-16 we saw the stock market chop sideways for nearly 2 years in a consolidation and separation process that left indexes about the same at the end as in the beginning.
By separation, I mean the good companies from the bad. Today’s bad companies would be the 100-200 zombie companies on the S&P 500 as discussed by Barron’s, Bloomberg and others. To be sure, not all of today’s zombies are really undead. Some will come back to life. Just not many. Keep in mind this ol’ gem from Uncle Warren: “Turnarounds seldom turn.”
Note the “huge support” zone on the left. While it is unlikely to me that the we see 2015-16 stock prices again due to the massive liquidity added to capital markets, it is not unlikely to me that the path upward is a lot less direct than the past 8 months.
Remember, several better analysts here, including myself, about a year ago were saying a correction was in store for markets.
I even said this far before the crowd:
Imagine a world without Covid and massive Fed liquidity injections. 2020 could very well have been a choppy year. Now, suddenly valuations are even higher and there is permanent damage to the economy that requires a prolonged rebuilding period.
The question we ought to be asking is: what is the path to consolidation and separation?
A Trading Range For Markets
Several years ago, I had a twitterscussion with Mark Yusko in which we discussed the delusion of markets at the time. We had different views:
I ended up being pretty spot on as 2018 saw corrections of about 9% early in the year and then 19% to close the year. The SPY did then top 300 into year-end 2019.
Where are we on the “stages of a bubble” for the stock market now? Well, the Federal Reserve injections have certainly altered the equation a bit, but I think we are near or at the delusion stage as I discussed a couple months ago:
That doesn’t mean that stocks can’t push higher yet. 4000 on the S&P 500 is a shiny round numbered object and people love shiny round numbered objects. I think we see 4000 on the S&P 500 sometime this year.
I also think we see the S&P 500 near or below 3000 at some point. See my chart above. I think a correction either stops around 3100 on the S&P 500 or follows through to the 2700s.
Could the stock market go lower? Sure, if there’s double dip recession, the Fed is a slow to act and fundamentals matter. That combination of things has not happened in a long time.
So, while a return to the March 2020 lows is not likely, we should not rule out the possibility. We should monitor that scenario as part of our ongoing forecasting adjustments.
What If The Republicans Keep The Senate?
The shape of things to come, in my opinion, does depend a lot of this week’s Georgia Senate election.
If the Republicans keep the Senate, then Senate Majority Leader Mitch McConnell can block President Biden at almost every turn. The next several years could turn out very similar to when McConnell blocked President Obama. McConnell’s actions slowed the economic recovery (see GDP and employment) and stalled stocks (see 2015-16).
I’ll break it down a bit further though. Don’t let your ideological panties get in a bunch.
The result of McConnell blocking President Obama was less fiscal spending, thus slower economic growth. Easy enough to understand.
That left the Federal Reserve as the only game in town to support the economy, which anyone who pays attention knows is a trickle down economics tactic. I’ll leave it to you to decide if that’s good policy.
With the Fed driving policy, that means that assets will continue to inflate, until, the economy sputters again. In which case, the zombies, either need to be bailed out, or left to die in the wilderness.
When (not if) the next economic hiccup comes, then stocks get kicked in the jaw as usual. Presumably the Fed rushes back in. But, what if something is different next time?
U.S. Treasury Secretary Steven Mnuchin announced he would be pulling more than $400 billion from the Federal Reserve’s market support programs. Those programs were necessary, at least according to the Fed and Treasury, so pull us out of a massive economic collapse. I covered that more in depth in this piece:
I don’t have any doubt that the Fed comes riding in at some point. But, the current firepower is much less than March and getting more firepower could run into Senatorial hurdles, especially, if politics are involved.
And then there’s this. Even without more fiscal spending, the tax cuts would stay in force, meaning trillion dollar deficits are here to stay. That’s negative for the dollar. I’ll discuss that in its own section.
While the short term with the Senate in McConnell’s hands could be good for investors, especially those looking for an exit, the next 2 to 4 years would look rough to me economically. Eventually, economics and fundamentals matter.
The short answer here is: sell the rips.
What If The Democrats Take The Senate?
Understanding these charts is understanding Democratic motivations.
The relationship of Fed QE to the S&P 500.
The relationship of U.S. debt to wealth flowing to 1%.
Adding the Fed balance sheet of about $7.5 trillion to the national debt of about $27 trillion brings America to about $34.5 trillion of debt.
The total wealth held by 1% of the population is, get this, about $34 trillion.
That means that the deficit spending, which has been fueled by tax cuts that went 80-85% to the richest 1% (via personal income tax and corporate income tax cuts plus loopholes) according to the government, has funneled virtually all of the gains to the 1% with the remaining small portion falling to us in the upper middle class investing class.
If the Democrats take the Senate, there will be massive changes to this equation.
A repeal of the tax cuts for people making over $400,000 per year, as well as, a change in corporate taxation. Capital gains would be reported as income for those over a certain income threshold, I anticipate that would be tied to the $400,000 promise. These changes to the tax code would hit stocks initially.
We would also see a continuation of the firmer trade policies on China, but our trade relationships with our allies would be quickly repaired. A net positive.
We would also see the large infrastructure, education and healthcare plans that have been on the agenda for 12 years. Combined with the tax increase on the richest Americans (if you are not an accredited investor, that’s not you), that would stimulate the economy – with a lag.
Ultimately, growth, which is what the conservative Heritage Foundation keeps pointing to as the solution to America’s problems, would drive the economy and stock market higher, with a marked reduction in wealth inequality.
The short answer here is: buy the dips.
Watch The Dollar For Clues
There is a consensus that the dollar is going lower. I identified that much earlier when I discussed gold in 2020.
Here is my working chart on the dollar:
Right now, the dollar is at a perilous spot. It is entering a range that could soon impair the American economy significantly. While the Fed decries a lack of inflation, that is clearly not true. Risk assets have inflated quite nicely. So have quite a few needs of daily life.
Here is calculation of inflation by Shadowstats that used an older government calculation of inflation. I think it is generally fairly close to reality:
That seems to jive better with my experience monitoring rents, hotel rates, price of cars, entertainment costs, food prices and insurance. What are your thoughts? Do you really believe that inflation is under 2% based on your experience?
Given high unemployment, with much of it permanently disrupted, and economic growth that has lagged debt creation since the financial crisis, there is a very clear bogeyman that we should be afraid of.
For those of you too young to remember, there was a period in the late 1970s and early 1980s with high unemployment and high inflation. It was brutal.
It was at that time, under President Reagan, that we decided to collectively abandon responsible economics and borrow from the future perpetually. This approach has been a recurring war on the dollar for 40 years.
There was some sense in it though. Back then, a strong dollar was an impediment to trade. Today, it is not. There is a new paradigm in trade driven by machine learning, cheap energy and resources.
No longer do labor wage differentials place supply chains and drive trade. Supply chains are moving closer to two things, end consumers and resources.
A robot here costs the same as a robot there. Minimizing the costs of getting goods to consumers revolves around negotiating resource and transportation costs now. In other words, it makes no sense to produce across an ocean if the resources are here.
America has both end users and resources. We do not need to devalue the dollar anymore. In fact, we want a strengthening dollar to protect purchasing power. We also want a stronger dollar because as a resource rich country, especially in food, we want to be paid a better price for things that are produced here and scarce elsewhere.
That is where the “goldilocks zone” in my dollar chart comes in. We need a strong dollar for Americans to purchase with and get paid in, but not too strong or we destabilize other nations who are our trade partners. It is a balancing act.
I talked about this day coming way back in 2012-13 on MarketWatch when I predicted America would be energy independent by 2019. The massive shift in energy from expensive fossil fuels to cheap all of the above energy is another paradigm shift, along with machine learning, and it has a direct impact on the dollar.
Hanging onto weak currency approaches will kill any economy in time given the new reality of supply chains, energy and resources.
America is better off in the dollar goldilocks zone. If that is where the dollar goes, which I believe it would under a Democrat Senate, then stocks will go through the consolidation and separation phase.
If the dollar plunges, then we will see a spectacular pump and dump with the Armageddon scenario in my SPY chart possible.
Bitcoin Is Probably Doomed Or Not
Since I have discussed the dollar, let’s discuss Bitcoin too.
I have been studying Bitcoin (BTC-USD) for several years now, from the technology to the economics to the legalities. There are really only two conclusions that investors can make about it right now:
- It’s a pump and dump that the government will eventually destroy.
- It’s a new finite commodity that can be used as a true store of wealth the way that Michael Saylor at MicroStrategy (MSTR) has been betting on.
I will write a lot more about Bitcoin in coming weeks, but the short story I believe, is that U.S. Treasury Secretary Yellen will say something about Bitcoin that makes it very difficult for it to expand. I don’t think governments and central banks would, or should, and maybe even can’t, destroy Bitcoin, but they can make it’s life very, very difficult and lower priced.
If nothing else, a stronger dollar policy is bad for Bitcoin. I think a ban on using it with any SWIFT or U.S. financial institution would have a massive impact on it. Think about how Square (SQ) would react.
I can even see massive penalties for tax avoidance along with a 20% penalty tax just for trading it, much like an early IRA withdrawal. Do not put it past governments and central banks to cripple Bitcoin.
I would also consider that the digital dollar, Euro and Yen are all coming. They will be pegged to some measure of CPI or economic growth with built in countercyclical policy, i.e. no reductions in supply during recessions. And, the blockchains will be maintained by SWIFT and U.S. financial institutions who collect fees for doing so. Quite a quid pro quo there. Save fiat currencies, save the banks.
Of course, Bitcoin bulls do have a point. It is a finite commodity. Stop there. It is a commodity, not a currency. Being a currency would in fact be illegal.
In a world of depreciating currencies, because capitalism needs some inflation, Bitcoin can be a long-term store of value if widely enough adopted. I doubt that adoption.
If you want some Bitcoin exposure, I have advised, similarly to Chamath Palihapitiya that you put just a percent or two of bank of your bank savings into Bitcoin. Or, if you don’t want to deal with direct Bitcoin ownership, but want to believe, or just hedge your bets a bit, buy the dips on Square.
Closing Investment Thoughts
The sustainable smart everything world that I have discussed for almost a decade now is accelerating. All the paradigm shifts we are seeing are connected to the advancements in technology and move towards sustainability. My investment plans are illustrated with this barbell:
Redeploy your cash to companies and industries that benefit from the secular trends. Use the barbell.