by Franklin J. Parker, CFA
- The Fed’s annual Jackson Hole symposium (virtual this year) dominated market sentiment last week. In the end, chairman Powell declined to offer a specific timetable for tapering asset purchases, however he did suggest that it is likely to begin before the end of this year. That would likely put an announcement for timing at the September meeting, with a beginning to tapering in November or December. What caught market attention were his comments with regard to interest rates. Powell suggested that the Fed would be in no hurry to raise interest rates after tapering. Markets bounced at that comment.
- This week we get the usual beginning-of-the-month flurry of data. Consumer confidence figures post today, PMI data posts on Wednesday, weekly initial jobless claims post on Thursday along with factory orders, and Friday we get the headline unemployment rate and personal income stats. The headline unemployment rate continues to be a closely-watched figure as it is a key input into the Fed’s assessment of economic health. Headline unemployment is expected in around 5.2% and personal incomes are expected to have grown about 4% year-over-year.
- Obviously, your financial goals will be the ultimate arbiter of your portfolio strategy. From a macro perspective, however, my advice has generally been to be invested, despite the absurd valuations at which companies are currently trading. Those stretched valuations are entirely the result of current central bank policy, and are likely to normalize as the Fed removes their support (which may or may not mean lower prices). However, the Fed is continuing to support markets at least through the end of the year, and corporate earnings have been very good overall. This gives investors two tailwinds until at least December. Furthermore, August price action has been a good sign. Corporate earnings growth has been very strong and rather than continue to run higher, prices were largely flat. This means that valuations have already begun to moderate, and to moderate without a loss to price. Of course, there are plenty of risks to investors in markets, but overall, at least for the moment, I see an upward bias in prices.
Of all the factors that drive investment returns—whether it be momentum, relative valuation, size, country, or sector—the most important factor in 2021 has been share price. On its own, share price is a meaningless statistic. Companies can change the number of shares they have to change the price (doubling the number of shares cuts the share price in half, for example), and that does nothing to change the actual value of the business. Even still, this meaningless statistic has been the most reliable predictor of returns in 2021.
To understand my perspective, we need to first understand how people interact with financial markets.
Traditional theory would suggest that prices are always right—they will always reflect all fundamentals of a business and expectations for the future. While I do generally agree that people will quickly adjust prices to new information, I find that whole theory woefully incomplete. My own research indicates (and I’m not the only one, of course) that people interact with financial markets with the intent to accomplish goals. They want to retire, send children to college, and buy a vacation home. These goals come in all shapes and sizes, and tend to range in importance. Some are absolutely required, some are nice-to-haves, and some are aspirational. Because of these objectives, investors will consider not just all information about an investment, but also how well that fulfills the job they need doing. In the aggregate, then, prices reflect all information about the security, and also the needs of all investors.
This is, in my view, the only way to explain many of the “anomalies” we see in markets today, like how low share prices can be a return driver.
Now, for goals with low importance—goals we may dub as aspirational—my research also predicts that investors will pay a higher price for more volatility, for more risk. People gamble, in other words, and, in some instances, it may be rational to do so. This is, of course, completely counter to traditional economic theory, but it is supported by peer-reviewed logic and rigorous math.
The price action we have seen in meme stocks (like AMC, BB, and GME), along with the excess return we have seen in low-priced stocks, is consistent with investors who (1) see lower-priced stocks as a source of excess volatility, and (2) have seen significant cash inflows. Given those two conditions, these anomalies are entirely predictable with a goals-based theory of markets.
Chart of the Week
Covid relief programs have, up until recently, made up a significant portion of year-over-year growth in personal incomes. As more workers return to the work force, Covid relief programs come to an end, and inflation in higher from supply constraints, the growth in personal incomes have started to lag inflation. This may be transient. However, it is also indicative of a liquidity trap, and may be an ongoing consequence of excessive money-printing. Investors should keep a close eye on these figures in coming years. If this is a long-term effect, it will significantly dent consumer spending.
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