Congratulations! We are officially halfway through the longest year ever, we should all get two birthdays this year for everything we have been through. This year has quite the roller coaster but more than ever before it has been a year of change, years from now we may be telling our kids of year’s pre-2020 and post-2020. As an extension of this, the investment market is also reacting and companies that fit the mold of the future are prospering and companies of pre-2020 are falling behind.
Focusing on the market let’s take a look at what is taking us higher and why. Firstly, COVID-19 progression. While cases continue to swirl some unknowns are being solved which is allowing for further and further reopening’s. To start, there have been greater and greater testing procedures and awareness to catch the virus sooner to give those who need help earlier which greatly increases the recovery rate. Secondly, treatments and PPE are growing every day. The production of PPE has increased dramatically where now people are not scrambling for tools to treat this virus. Also, there have been strides forward in medical drugs to help fight the virus, dexamethasone being one of them. This cheap anti-inflammatory drug has soon to have positive effects on the recovery rate of COVID-19 patients and there are others that have also shown promising results given certain situations. Lastly, the progress in developing a vaccine continues to move along. Some drug companies believe October-November of 2020 could be their target date while most governments believe it will be early 2021. Either way, each passing day is one day closer, it is very important though that these are tested properly and thoroughly in order to ensure a safe vaccine. The first two have reduced the amounts of COVID related deaths even though cases continue to rise, while the last point gives hope of many fewer deaths in the future. This progress has given investors a lot of optimism for the future and thinking one day we can get back to a “normal” economy.
While the progress on the virus continues and gives investors hope for the future. The government has done a pretty good job of bridging the gap while many people sit at home. Around the world, government stimulus programs have given people enough income to keep the economic engine running while many do sit at home. So far, this has done its job and is a big reason why the stock market continues to run as the new money supply has kept many businesses from declaring bankruptcy and consumers buying goods. In the US, this plan runs out on July 31st, 2020 which many are hopeful that the government passes a further stimulus bill in the $1 trillion dollars plus range to keep everything running smoothly until September. The Canadian along with many other economies has already extended this plan, so the thought is that the US will also continue. This along with low-interest rates is a stock market dreamland and it is not too much of a surprise that it continues to push higher.
The stock market continues to climb as stock prices rise but under the surface, the progress is not as strong. So why are the prices rising? The thought is that companies are laying the foundation for the future and once everyone is back to work this will be a temporary blip on the radar. Many “post-COVID” companies are seeing massive increases in their valuation (price vs. sales or earnings) based on the fact that they will be the companies of the future. Companies like Zoom Video, Netflix, and Shopify are trading at values that in “pre-COVID” would have thought to be insane. But, in a “post-COVID” world people are assuming we will use these more than their previous iterations, which would be in-person meetings (Zoom), movie theatres (Netflix), and retail shopping stores (Shopify). This for a large part is true but these valuations are pulling up the rest of their counterparts in their space where every one of their peers is receiving a high valuation. This does remind us of the DotCom bubble of 2000 when the internet was coming online and the thought was we were going to all do a portion of our shopping online. As a result, every internet company started to receive a massive valuation because they were all going to be successful. In reality, not all these companies will be successful, but there will be some very successful ones. Amazon, eBay, and Priceline all came from that era and were immensely successful. We are not saying this will end the same way and the valuations are not as high as they were during the DotCom era. The online space is much broader than in 2000 (which was the biggest downfall of the time) but at some point revenue and earnings will need to catch up for these companies to justify the price.
The market continues to look passed current fundamentals based on the following:
2020 = Write-off
2021 = Progression to “new-normal”
2022 = Full “new-normal”
This means that investors are giving companies a pass for 2020 and starting to predict their 2021/2022 results when they are in a “normal” economy. This is a very difficult task because predicting 3-6 months out has a small room for error while predicting 2 years out has a much larger degree for error. Therefore, inherently purchasing these companies based on 2022 sales and earnings does come with additional risk.
So the next question would naturally be: Will we go higher or go lower from here? The answer is never simple but the trends that have brought us to this point are currently not changing. Interest rates globally should remain low until the end of 2022, governments have declared that they will continue with stimulus until the end of this year, the progress on COVID-19 should only get better going forward (progression on treatments and a vaccine) and the employment picture continues to improve as the reopening continues around the world. As long as we move on this path there is little reason to go lower, valuations are usually a going concern but the market is giving companies a free pass for 2020 (so far). It will take a wrench or two in the current game plan to bring us lower. The problem is we are moving at about 140kmh on the highway right now and that may not need to be a big wrench, so we need to proceed with caution.
Current near-term issues in the market:
1. COVID-19 – 11.5 million cases globally, is a large number. The spread needs to slow and a solution needs to come. If the previously mentioned outcomes don’t happen, it could derail the recovery as it could force a reversal in the reopening’s especially when fall comes and we are forced back indoors. If cases continue to rise treatments and a vaccine must rise along with it for the market to continue to ignore the cases.
2. US/China Trade Wars – This may be an issue coming up. The Hong-Kong bill just passed and now protesting could come with a penalty of LIFETIME in prison. Which we guess is an easy way to stop protesting, glad we don’t have to deal with this problem in Canada. The US is thought to place sanctions on China for this and could reignite the trade war.
3. US Elections – It’s about to get serious and the gloves are about to come off. Prepare for some volatility going into this, where certain sectors could come under fire. One main area is technology, with Biden leading in the polls, this could pull forward the Democrats targeting is mega-cap tech stocks (Apple, Amazon, Google, etc.). As the largest companies in the indexes increased regulation could really put a strain on the market going higher. Also, expect further social divide in the US throughout the summer leading into these elections.
4. Employment – We NEED to continue to add jobs. Government stimulus will not last forever and the effects of not having employment without government payments will start to show in the next 3-6 months. If there is a slower re-hiring process it will be tough for our consumer-led economies (the US and Canada) to continue to move forward.
Going forward we have a few predictions of trends that should continue based on what we see.
1. Commodities should continue to rally. Cheap money is raising the price of commodities, gold, copper, wood, etc. allowing it to continue to rise. Gold has also been driven by inflation expectations, copper has also been driven by COVID cases in top copper-producing countries, and wood by a large increase in home improvement.
2. Oil to rally. While this would be expected to be temporary, rig counts around the world have drastically dropped. In the last year the US has gone from 963 to 263, Canada 120 to 18, and internationally 1,138 to 781. Production has come down drastically but so has demand. Demand can come back faster than production, so there could be a small window where production will lag demand and create the perfect storm for an oil run.
3. Renovations to continue. Homeowners are spending more time at home during this pandemic and this gives more time to renovate their homes. With the ability to travel down we expect this to continue through summer.
4. Very little international travel. While the progress on the virus is good, cases are still rising and governments are leaving travel restrictions on. Without the strong summer months of travel, we would not expect a lot of travel this year.
5. The stock market should continue to rise. While we are expecting more volatility going forward and we do believe the market will be higher at some point during this year. This may mean going lower before we go higher but if the current trends continue there is still room to move higher.
6. Coronavirus will not go away. There is no indication that coronavirus will cease to exist, expect to be living with this for a long period of time. Adjust accordingly.
7. All sports will be back, with new ways to watch. Prepare for an interactive experience next year.
2020 is so far a year to remember (or forget) and could get even more exciting going forward (we hope not). This is a year for change, whether wanted or not we will need to adjust going forward. Embrace the change and set your feet for the years to come.
As always, the above-mentioned opinions are subject to change as more information is disseminated. It is very difficult to predict what will happen in the short-term with so many variables in play. However, we are confident that we see long-term trends developing and we should position ourselves to invest appropriately. We continuously preach investing in a balanced portfolio between public and private markets to help reach your financial goals and also reducing the overall volatility of your portfolio.
Konrad, Justin, and Merriel
More articles and information is available at www.lkwealth.ca
Source: BCA Research, Bloomberg, Reuters, Yahoo Finance, Trading Economics
Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.
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