Looking Beyond The Wall Of Worry

Markets hate uncertainty, but that's about to change as we will soon know who will be president in a few weeks. We will know if there's a new stimulus bill shortly, and we should see whether we have at least one vaccine within two months.

Regardless of the near-term outcomes, the Fed will have our backs, and the economy has enough momentum to carry us well into 2021 when we expect all these issues to be resolved positively. 2021 will be a year of continued aggressive monetary ease, multiple trillion-dollar stimulus programs regardless of who is president, and the roll-out of many effective vaccines by mid-year. We have raised our expectations for economic growth meaningfully for both 2021 and 2022. We expect earnings to be knocked out of the park as managements keep a tight lid on costs, achieve substantial productivity gains, and generate an immense amount of free cash flow, which will be used to hike dividends, buybacks, and acquisitions. Expect operating margins to exceed prior peak levels by the second half of 2021, benefitting from positive operating leverage/tight cost controls, and then go even higher in 2022.

All of this will be occurring against the backdrop of an overly accommodative Fed, which will permit the economy to run hot. There are trillions of excess liquidity in the financial system well above economic needs. Besides the Fed, look at the trillions of deposits held at banks both here and abroad. All this money will be searching for a home, which is another reason we remain favorably inclined towards risk assets. Again, if Biden were to win, we would not expect any tax hikes until the second half of 2022 at the earliest after the economy exceeds prior peak levels. Hopefully, President Biden will see the fallacy of his ways and implement a tax plan that supports growth, higher employment, capital investment, and research spending. Growth is a necessity to pay for all the social programs on his agenda. Trump, if president, will maintain a pro-growth agenda along with reduced regulations.

News on rapid response tests, therapeutics, and vaccines was all positive last week. We fully expect a surge in cases as we move through the winter, but the time spent in hospitals and death rates will decline meaningfully due to better techniques/therapeutics. Gilead's (NASDAQ:GILD) Remdesivir was fully approved as a treatment for the coronavirus and should be readily available for all shortly. We also heard that AstraZeneca's (NASDAQ:AZN) and J&J's (NYSE:JNJ) Phase 3 tests had resumed without reservation. Pfizer (NYSE:PFE) should be the first out of the gate with a vaccine before the end of November. Its vaccine will be initially used on an emergency basis only and then distributed two months later throughout the country and abroad. Rapid response tests are being rolled out in volume and will permit opening to accelerate safely, which will more than offset a rise in cases that force some shutdowns.

Listening to earnings calls has given us a greater sense of the strength in most sectors of the economy along with much higher operating margins. U.S jobless claims fell below 800,000 last week for the first time in six months; U.S home sales rose to a 14-year high; auto sales, especially trucks, are robust, as can be seen in used car/truck prices; and overall retail sales are already above pre-pandemic levels. Specific sectors such as airlines, hotels, cruise lines, and hospitality are being hurt, but most other sectors are strengthening at a surprisingly fast rate. So, while aggregate consumer credit is not growing, look underneath the hood, and you will see pockets of strength.

The manufacturing sector is racing to catch up with demand. It will take many months for inventories to return to normal levels. This is a worldwide phenomenon. Manufacturers' PMI indices are strong, hanging in the mid-50s both here and in Europe. The same phenomenon occurs in China, where manufacturing PMIs are much stronger than services and consumer sales. Pricing is improving, too, as utilization rates rise. Just look at the US steel market where three price increases have taken place over the last two months, and another one is currently being implemented. Look at copper and iron prices, too. They are hitting multi-year highs. Industrial commodity prices are apt to increase much more over the next 18 months as demand increases outstrip supply growth. Massive productivity gains and global competition will keep a lid on overall inflation, but it will move up from here over the next two years if the Fed abstains from any policy change. Now, can you understand our shift in portfolio composition shifting more cyclical, emphasizing industrials and commodities, ex-oil? Continue to sell all fixed-income regardless of the Fed's desire to suppress rates as the yield curve will steepen as it has over the last month. Should the 10- and 30-year Treasury yields be 0.81% and 1.62%, respectively, with inflation running at 1.5%? Not really!

The election is getting closer, and it appears that Biden will win. We fully expect that he will push for several multi-trillion stimulus plans next year. Regardless of the outcome, the economy will have additional trillions in stimulus to help individuals/businesses make it to the other side, AND several trillion in demand-focused programs to create jobs like infrastructure. Imagine $4-6 trillion in stimulus packages next year on top of all the financial system's excess liquidity. Remember that we expect vaccines to be readily available by the second half of 2021, permitting more openings. We may have a booming economy with a passive Fed. Wow!

Investment Conclusions

The stock market continues to be undervalued for several reasons: tremendous excess liquidity is forcing investors further out on the risk curve; multiple trillion-dollar stimulus plans on the horizon to boost economic growth; vaccines on the horizon permitting a return to some semblance of normalcy by the second half of 2021 into 2022; and finally, record profits in 2021. Hard to beat a combination of low interest rates and much higher profits/cash flow. Stay the course!

The facts continue to support shifting the portfolio's composition to have more cyclicality as we expect above consensus economic growth in 2021 and 2022, along with significant improvement in operating margins, leading to earnings growth well above current expectations. While we will maintain significant holdings in technology due to its great, long-term outlook, we had to continue to use this sector to fund our other purchases. No remorse, as this sector offered us sensational absolute and relative performance over the last six months, but we see relative underperformance ahead as markets broaden out to more economically sensitive areas with tremendous earnings leverage. We have maintained our positions in a few market-dominant retailers who will continue to benefit from more time spent at home, along with a shift to online purchasing.

Again, we want to mention that the large, well-financed companies with forwarding-thinking management are in a great position to pick up significant market share from their smaller competitors and make bolt-on, non-dilutive acquisitions, thereby accelerating their growth rates. It is one of our core beliefs. It is incredible how much low-cost capital is out there for companies to refinance debt at lower rates and fund deals. M&A will continue to surge, benefitting from all this excess liquidity reaching for returns. Our emphasis today is on global industrials, commodities, and transportation. We own no bonds.

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Review all the facts; pause, reflect, and consider mindset shifts; look at your asset allocation with risk controls; do independent research; and...

...Invest Accordingly!

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.