People still think this is a frothy market. 

It is frothy – but in isolated pockets, which is an important distinction, and we’ll get to those examples in a moment.  But let’s not forget where we once were.

This is the 20th anniversary year of the Pets.com IPO.  On the basis of a url address and a Superbowl ad, Pets.com priced at $11, saw its stock jump 27% on day one and was out of business in a year.  In 1999, 550 IPOs were priced and the average FIRST DAY gain was 70%.  Average.  Before the COVID, the S&P was trading at 22x.  In 2000 at the peak it was 30x.  The NDX 100 was trading at 28x this year and 40x at its 2000 peak.  The largest name in the index now, AAPL traded at 24x this year.  In 1999 it was MSFT as the largest index component and it peaked then at 60x.  In 1999, the NDX was trading at 73x with a free cash flow yield of 0.75%.   In late 2019 the NDX was just at 26x with a free cash flow yield of 4.35%.  We get the incredulity.   But you should have seen it 20 years ago.

We didn’t think this was worth commenting on again since we have done so before.  We were wrong; apparently the misperception is hard to quash.  The other popular myth is that a concentration of return from Index giants is a bad thing.  To wit, one sees this a lot.

The next time someone points out index weights to you, the response should be: Why is that a problem?  Have you seen the net income contributions of each bucket?  The top ten S&P 500 stocks comprise 29% of its weight.  The top ten S&P 500 stocks also generate 22.6% of the S&P 500’s net income, and 19.2% of the S&P 500’s free cash flow.  Apple is 5.71% of the S&P 500’s market cap yet it generates 4.79% of the index’s net income and 4.57% of its free cash flow.  Microsoft is 5.66% of the S&P 500’s market cap, generates 3.76% of the index’s net income and 2.97% of its free cash flow.  One could argue the S&P is undervalued based on the contributions from the top of the Index.

Look at the contributions of NFLX and BAC by comparison from the table below.  One can (almost) make a bull case for BAC based on this.  BAC provides 1.27% of the net income, has the same weight as NFLX, but makes four times the contribution to the Index’s net income as NFLX.  And NFLX is the market watcher’s darling.

Source: Bloomberg and FlowPoint Partners, LLC

Source: Zerohedge

It’s not just Tesla.  SHOP is trading at 1,630x EPS, 43x sales and 1,333x EBITDA (all ’21 ests.).  You read that correctly: one THOUSAND six hundred thirty times earnings.  SHOP is definitely executing well in the e-commerce sweet spot and growing 150%+.  But how much future growth is already discounted?   But neither Tesla nor SHOP (or pick any of five other unicorns) are “the market”- they are the outliers.  If this were the year 2000, every car company would have TSLA-like mkt caps.  But they don’t.  Only one does.  (Well, now two with the insanity surrounding NKLA, but you get our point).  In fact, other car companies are trading at single digit p/e’s, which is where ALL car companies should trade.

Back to the markets, we get it, after months of COVID doom, it’s hard to see through the gloom, but see it through we must.  The quote from our economist Don Luskin appears atop this Blog section of the website for a reason – it’s a point none of us should ever lose sight of.  Most of the world too often focuses on data that is already in the rear-view mirror.

The earnings upgrade cycle will be driven by a V-shaped recovery that is already occurring.  We’ve had a 21.8% decline in earnings estimates y-o-y peak-to-trough as a result of COVID impacts.  (In 2008 by comparison it was 38.9% peak to trough).  While 21.8% is pretty rare and extreme, it more means the rerate higher for earnings estimates will likely be equally steep.

Source: Trend Macrolytics, LLC

You should also expect a shorter-than-average recovery period because, according to the Fed, we are already in recovery now.  The Fed is saying the trough was April, making this the briefest recession on record.  There have been ten recessions since 1950’s – seven took either two or three quarters to re-attain previous peak GDP.  This short duration recovery from such a steep decline is what skeptics struggle with the most.

Source: Trend Macrolytics, LLC

Source: Trend Macrolytics, LLC

Finally, the Fed has plenty of room let to stimulate.  You’ve read a lot about the Fed buying mortgage paper and corporate debt, which is not that extraordinary.  What never gets discussed are the Special Lending Programs like Payroll Protection and other monetary levers at the Fed’s disposal which have barely started.  That is supportive of higher markets.  The Fed has said it has lending capacity of $2.3 trillion in the unconventional programs such as MMMF, Paycheck Protection, Main Street, Corporate and so on. The tiny holdings in these programs (so far) mean that there is HUGE capacity remaining if people want this access to credit. Fed “not running out of bullets” by a long shot.  You hear talk of the “Fed Put” which is usually a complaint by market bears that the Fed is artificially propping up asset prices.  That is a distortion.  The Fed is doing what the Fed is supposed to do: insure the free flow of credit.  If the Fed were truly worried about inflation, the bears’ biggest bugaboo, it would promote other courses.  The Fed is telling all of us that deflation is the larger risk and the Fed is correct. 

Source: Trend Macrolytics, LLC

While many important economic indicators are turning up (restaurant bookings, gasoline consumption, cellphone implied mobility, etc., state jobless claims), stupid local politicians could absolutely derail a rebound.  They put us in recession in the first place, and they certainly could do it again.  But we do not believe the COVID data is indicative of any second wave or the need for more lockdowns.  If, and this is a big if, local pols focus on the correct data points – case fatalities – we believe the risks of future lockdowns to be small.  It does not matter that more tests are coming back positive.  Indeed, one could argue this is a positive development as most new cases are in the younger age cohort, most COVID cases have always been mild, and all of this will lead to herd immunity, a very important step in the battle against this virus and dumb politicians.  But, if politicians are smart enough to step away from the microphones and turn the greatest economic force on the planet loose once again, equities will continue to rise once again and reflect the reality in front of us and not the reality in the rear-view mirror.

Source: Trend Macrolytics, LLC

In the past few months, to better isolate the COVID and post COVID impacts, we have created two proprietary indicies – one consisting of stocks best positioned to take advantage of the Work From Home phase we are in and those best positioned from a reopening of global economies.  Creatively, we have titled these two the “Work From Home” and “Reopen” indexes, respectively.  How clever are we?  Both indexes are available on Bloomberg.  Interestingly, but not surprisingly, here is the dispersion between the two since March, 2020.

Source: FlowPoint Partners, LLC and Bloomberg

This should tell you that not everyone has benefitted from the sharp rebound in equity prices.  While it will be interesting to refer back to both of these indicies and see performance against each other as an indication of changing market sentiment, it is more interesting to merely note the divergence.  Why?  We are still in a market where dispersion is having an impact on returns.  Active managers have been outperforming in this environment because it is in periods of heightened volatility that good active managers always outperform.  And if they don’t, you need to replace your manager.

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