Stocks Continue Move Higher

So far stocks have started 2021 much like they ended 2020, with the S&P 500 and the Dow hitting new records. With that being the case, let’s take a look at some key market developments.

money supply

Between the Federal Reserve and Congress, money supply growth exploded in 2020 in response to the coronavirus pandemic. There is no sign of that changing as we begin 2021. In fact, with the Democrats winning control of the Senate, which in November we predicted had a greater than 50% likelihood, spending from Congress is expected to see a substantial increase. This is the biggest factor driving stocks so far in January. The question is how long can the Fed and Congress maintain higher spending before inflation shoots higher? Many predicted inflation following the Federal Reserve’s quantitative easing programs in the aftermath of the Financial Crisis, but most of the money just sat on bank balance sheets with tepid loan demand from businesses. This will bear close watching as 2021 progresses.

stock valuations

Stock valuations remain stretched on a historical basis with the S&P 500 Forward P/E ratio at 22. The Fed is going to keep short-term interest rates at 0% which many financial analysts argue support the case for higher valuations. That said, it is tough to make the case that stocks deserve a higher valuation leaving future price appreciation dependent on company earnings coming in stronger than expected in 2021.

small business sentiment

The NFIB released their December Small Business Optimism report which showed a decline of 5.5 points to 95.9. This is below the average score of 98.3 going back to 1973. Much of this decline in confidence is related to the recent surge in coronavirus cases, which has led to more lockdowns. Also, one-third of small businesses surveyed in early January indicated they would need additional funds in the next six months to survive according to the Wall Street Journal. Small businesses bouncing back from the enormous difficulties the coronavirus brought on last year will be critical to the strength of the US economy recovery in 2021.

Bitcoin

One of the biggest stories of 2020 was the price action in Bitcoin, which despite falling over 58% when stocks sold off in the spring, had a furious rally and ended the year up over 300%. In 2021 the volatility hasn’t changed with Bitcoin down 30% in the last ten days alone. This decline followed a 38% rise in the first week of January. Last year more financial institutions begin to buy the cryptocurrency and some companies such as Paypal and Square begin to allow account holders to purchase Bitcoin on their platforms. There is no question this increased adoption fueled some of the price increase. There are some signs that Bitcoin has reached at least a short-term “mania” phase, but it will be fascinating to see where the price of Bitcoin goes from here.

Consumers are flush with cash and if the vaccines can be effective in diminishing the spread of the virus as the year goes on there is no question there will be a spending surge as people resume travel, eating out and other activities curtailed by the virus. As always, markets will still have their share of hurdles to clear, one of which will be how aggressive the democrats get with tax hikes this year which we will examine in a future update. 2020 was a tremendous year for client portfolios, but we are in a new year and stand ready to guide clients through whatever 2021 brings us.