Bulls Tap the Brakes After S&P 500 Hits Record High
August 21, 2020
The S&P 500 hit a new record high of 3397.16 this week, powered by strong gains in tech giants Apple, Amazon, Microsoft, and Google-parent Alphabet as the stay at home plays retook the reins from economically sensitive plays. Apple alone hit four new all-time highs this week,surpassing the elusive $2 trillion in market valuation, a first for any U.S. domiciled company. It was a mixed week on the economic front. The real estate market showed continued strength amid the pandemic with buyers scooping up homes in droves. The strength in the housing market came despite a rise in first-time claims for unemployment which rose above the 1 million mark – just one week after falling below that level. After hitting its first all-time high on Tuesday, the S&P 500 struggled to make further gains once the Fed minutes were released showing that the central bank believes more government spending is needed to prevent the economy from regressing while Democrats and Republicans remained gridlocked on providing additional relief. Still, the strength in the market’s leading tech names was enough to push the index to its second all-time high, up 0.72% for the week.
Homebuying Lifts Prices to Record High
Sales of existing homes spiked an astounding 24.70% in July as homebuyers rushed to buy homes amid the pandemic. The strong demand drove the median price of a home sold up 8.50% from a year ago to $304,100. The strong demand drove the supply of existing homes down -21.1% from a year ago which essentially dried up the inventory on the market. With just 1.5 million homes available for sale at the end of July, there is only a 3.1 month supply of homes available. That is the lowest July supply in the history of the survey dating back to the early 1980s. One positive note is that listings appear to be running higher than a year ago, but they are quickly snatched up by buyers and taken off the market. Even though the unemployment rate remains high, pent up demand, low supply and historically low rates are creating a renewed frenzy for existing homes.
Homebuilders Can’t Build Them Fast Enough
Homebuilders broke ground on 1.496 million brand new units in July, up a seasonally adjusted annual rate of 22.60%. Meanwhile, data for June was revised up to 1.22 million units from a previously reported 1.186 million. The momentum doesn’t appear to be slowing with permitting activity (a metric for future building) rising 18.80% from June and 9.40% from July 2019 to 1.495 million. Gains were broad-based with double-digit gains in one, two, four, and five or more units. The numbers crushed economists’ estimates of 1.252 million for housing starts and 1.33 million for building permits. Overall, the homebuilding business appears to be a good business to be in during a pandemic as more homebuyers seek the serenity of a place to call their own.
Fed Lets Air out of Bulls’ Enthusiasm
Minutes from the Federal Reserve’s July 28-29 FOMC meeting were released this week. Central bankers expressed a rather downbeat economic outlook, causing markets to fall on Wednesday after setting a record high on Tuesday. The Fed remains concerned Covid-19 will continue to weigh heavily on the economy for some time and require even greater government stimulus to maintain the recovery. Since March, the Fed has pumped in $4 trillion in stimulus, launching a number of emergency lending programs to backstop markets, including buying up corporate and municipal bonds. While the central bank says that it remains committed to do whatever it takes to support the economic recovery, ultimately the Fed understands that monetary policy alone will not be enough to keep things going if Congress fails to act on additional rounds of stimulus.
The S&P 500 has managed to retake all-time highs – doing so in just 103 trading days. This is the index’s fastest recovery from a bear market ever, manufactured entirely by timely and massive central bank and federal government stimulus. While the trend in economic data has been strong over this same time frame, we still remain well below production, GDP, and employment levels seen in February, yet the market indices have consistently marched higher. Take a look under the hood of these indices and one sees that it has been the tech giants (Apple, Microsoft, Amazon, Google, and Facebook) driving the gains. These five companies comprise roughly 24% of the S&P 500, rising an average of 70% from their March lows. Broken down by style, the tech heavy S&P 500 growth stocks have outperformed value stocks by a margin of nearly 2:1, resulting in a valuation disparity whereby growth stocks are twice as expensive as value stocks (S&P 500 growth stocks trade at 32.76 trailing twelve months earnings versus S&P 500 Value stocks trading at 15.32x). Tesla, another tech favorite, saw its shares rise 25% this week alone.
We have been hesitant to call a bubble in tech, but we are doing so now. There are simply too many similarities to the last tech bubble of 1999-2002 – all of which a tech bull would counter as historically irrelevant. We beg to differ. The only question in our minds is whether we’re in a bubble or headed to an extreme bubble in that sector. A deep dive into the specifics is beyond the scope of our weekly commentary, but our statement extends beyond just a casual observation of relative PE levels between growth (tech specifically) and value. We appreciate these large tech companies as much as anyone, but we are cynical of the mythical status imparted to them by the investing community at large. These are generally good companies, but they are also really expensive and disproportionately benefiting from a near term event and the inevitable hype. As a proxy for this hype, you can look at retail trading. Retail trading – recognized as day trading in the ’90s and Robinhood today – is just a small amount of overall trades by volume, but it periodically emerges as a form of social entertainment and status. At times it reflects a deeper cultural obsession which permeates its way through the entire financial system, creating both blind spots and frenzy within certain sectors. We don’t think it is a coincidence that online gambling sites and retail trading platforms are both seeing a record influx of users since March, with the average retail trading client being 31 years old and 50% of new users having zero investing experience. Hazard a guess at what the most popular stocks have been? TSLA, AMZN, AAPL, MSFT, NFLX. We’re not throwing shade at anyone, but we’d be remiss if we didn’t point out that COVID has brought about a new societal mantra that “the world has forever changed”. Modernists have co-opted this to predict radical changes in urban development, while traders have used it to validate the price they pay for stay-at-home stocks. The problem is that this sounds a lot like “everything is different this time” when the phrase was used in the ’90s to justify why profitability was no longer an important metric in the valuation of dot com companies.
The point here is not to send investors running from tech. Even if we are in a tech bubble, it is probably early with room still to run (more like 1998). The comments are made to help our investors understand what is driving returns at present, and to point out that while parts of the market are fully valued, there is still a great deal of long-term value yet to be recognized. We don’t believe everything has changed forever – just some things – and once the pandemic passes, consumers are going to be tired of being stuck at home and the economy is going to be a lot more robust than simply tech.
The Week Ahead
In a sign of the times we live in, the Kansas City Fed’s Economic Policy Symposium, which each year brings global central bankers to Jackson Hole, Wyoming, will go virtual this year. The event will be livestreamed August 27-28 and be open to the public for the first time ever. If you would like to follow along, you can head on over to the Kansas City Fed’s YouTube page. This year’s theme is “Navigating the Decade Ahead: Implications for Monetary Policy.” Federal Reserve Chairman Jerome Powell will speak Thursday at 8 a.m. Central on how the central bank plans to achieve its twin goals of stable prices and maximum employment once the coronavirus pandemic has been vanquished. Economic news will be light with durable goods orders being the highlight of the week.
Tight Quarters
The U.S. is experiencing a coin shortage. Technically, there are enough pennies, nickels, dimes, and quarters to go around — more than $47 billion in coinage is in circulation — but the supply chain has been disrupted, creating a lack of inventory in some areas of the economy.
Coin circulation relies on a network encompassing the Fed, the U.S. Mint, banks, businesses, and consumers. The Fed is the issuing authority for coins while the U.S. Mint is responsible for production. The Fed provides the Mint with monthly coin orders, and the Mint transports the coin from its production facilities to Reserve Banks.
The Reserve Banks distribute coins to banks, credit unions, and other financial institutions to meet the public’s demand. Cash-dependent businesses are a key component to continuing the flow of coins through the economy. Due to the pandemic, many of these businesses temporarily or permanently closed. Changes in consumer spending habits have also contributed to the coin crunch. Additionally, the Mint’s production was temporarily impacted due to COVID but has since returned to normal. Much of the nation’s coin is simply not circulating through the economy without regular deposits from cash-based businesses. The Wall Street Journal reported that coin deposits at banks are down 50% since the start of the pandemic.
The Fed formed a U.S. Coin Task Force earlier this summer to boost coins back into normal circulation. They began rationing the distribution of coins to assist places that needed them the most and urged Americans to start spending their coins, deposit coins at the bank, or use coin kiosks to exchange their change for dollars. Many banks suspended fees for coin-counting deposits and some banks offered cash back bonuses in exchange for coins. A chain of convenience stores offered a free beverage to customers who brought change to their stores, and one laundromat owner adjusted his change machines to accept smaller bills to limit coin outflow.
A temporary closure of an aquarium in North Carolina turned into an unexpected opportunity to help with the coin shortage while offsetting lost revenue. The aquarium at Pine Knoll Shores shut down its waterfall as a cost savings measure, and then decided to clear out 100 gallons of coins that visitors had thrown into the makeshift wishing well over the past 14 years. It took several weeks for staff and volunteers to clean, sort, and count their change haul. The aquarium announced today that the amount of pennies, nickels, dimes, and quarters tossed into their waterfall totaled $8,563.71. The money will be used to help care for the animals.
The Federal Reserve has assured Americans that the coin inventory issues are expected to resolve once the economy opens more broadly and the coin supply chain returns to normal circulation patterns.