Investment Thoughts Q2 2021

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Dear Client,

Mark Twain is often credited with the saying, “History doesn’t repeat itself, but it often rhymes.”  It is an adage we find ourselves referring to frequently when it comes to the markets – often as a reminder that, whatever conditions we may be facing, we are almost certainly not the first to be doing so.

 Concerns about elevated stock valuations?  A worry shared by investors during the Tech Bubble of the 1990’s.  A global pandemic?  We haven’t gone a week during the past year without reading a reference to 1918, although 1958 and 1968 also experienced less severe health crises.  Worries about rising inflation?  It’s almost impossible not to have our thoughts turn to the 1970’s.

 The recognition that this path has been traveled before can be comforting, while also providing us with a template to critically evaluate the conditions and prepare an appropriate response.  Nevertheless, there is also a danger in becoming too comfortable and believing that we merely need to follow the roadmap from the past event in order to successfully navigate the present.  There is value in identifying the rhyme within history, but we don’t want to lose sight of the admonition that it does not repeat.

 How does that framework apply to the three primary storylines for the market in 2021?  Our view on each is as follows:

 Price-Earnings Ratios are expensive relative to historical averages, and by some measures rival the levels we last saw during the Tech Bubble of the late ’90’s. 

The statistic is correct, and the elevated valuations may not be sustainable over the long-term.  But acknowledging that is not the equivalent of stating the market is in a new bubble that must pop.  Many of the most highly valued companies today are well-established firms with substantial and rapidly growing earnings.  By contrast, the Tech Bubble is remembered for prizing start-ups that were showing heavy losses and showed no prospects of turning a profit for the foreseeable future.  The question in 2021 is more about determining the fair value rather than the 1990’s dilemma of attempting to predict whether any true underlying value even exists.  In addition, interest rates today are at much lower levels – a 6-month CD yielded over 4% in 1999 – which is more supportive of higher valuations.

 The coming decade could be a repeat of the Roaring ‘20’s as the economy rebounds from the pandemic. 

While many aspects of the Covid-19 pandemic have mirrored the path of the 1918-19 pandemic, extending those ties to the economic and financial prospects for the coming decade may be overlooking a couple of key links.  First, the 1920’s economy was also influenced by the end of World War I, and it is difficult to separate out the respective impacts.  But given the economic boom that also followed World War II (absent a pandemic), assigning 100% of the credit to the emergence from the pandemic would appear to be hyperbole.  In addition, the P/E ratio for the stock market at the start of the 1920’s was historically depressed, creating a more favorable environment for future stock returns and representing a far cry from our reality today.

 Prepare for a return of 1970’s-style inflation. 

These fears are primarily stoked by the record levels of government spending and debt.  We even had a brief flashback to the gas shortages thanks to the recent cyberattack.  A surging economy paired with easy monetary policy from the Federal Reserve is a recipe for rising inflation; however, there is a world of difference between a move away from the ultra-low inflation we’ve experienced since the Great Financial Crisis and a return to the double-digit inflation rates that characterized the late 1970’s.  Two ingredients from the ‘70’s recipe that are missing today: elevated inflation as a starting point (was running 5-6% at the start of the 1970’s) and a disruptive event such as President Nixon moving away from the gold standard.  (See more about potential inflation in our featured articles.)

We want to be aware of history, but also recognize that our current chapter is still being written.  We hope you find that perspective helpful as you come across financial news headlines that simply want to “connect the dots.”With summer kicking into full gear, we hope you are able to take the time to write an exciting chapter in your own family story.  We look forward to hearing about your adventures!

Sincerely,

Greg, Jodie and Chris