Valuations in the market are very stretched, advancing to levels not seen since the early 2000’s. Monetary and fiscal actions tied to COVID-19, including historically low-interest rates and stimulus checks, drive equity prices higher, while traditional financial ratio analysis and fundamental business drivers are more and more put to the side.
In my opinion, this is not a good thing.
My long term, up-close observation of the markets makes it very difficult to be excited about the seeming euphoria of the current market period in my view. In the end, we know that when the music stops and the chair is pulled, the drop can be painful.
It leaves me in an awkward position because my basic investment strategy is picking ideas for the long-term, based on trends that are likely to change the way we live over a generational evolution. I have been pretty successful using this model.
But when stocks are attracting valuations based on aggressive forward projections, buying for the future is increasingly tricky since today’s market is trading as if that aggressive (and unlikely) future were already here.
I expect plenty of disruption in 2021. In my opinion, the most significant risk is rising rates on the 10-year Treasury and its potential for climbing to around 1.5%, and the concomitant inevitable fears of inflation. In my estimation, I don’t see inflation actually returning in the foreseeable future. The current pace of money printing and GDP growth are so misaligned that inflation cannot emerge. For inflation to spark, GDP growth needs to be more than that of the money supply. In my opinion, that may not happen this year, or likely any time soon.
There will, though, be some false signals. Remember, the first half of 2020 saw commodity prices and demand collapse, and that means when periodic 2021 readings start to compare against prices from 2020, it will appear as if inflation is hot. I believe that illusion will spark the rise in the 10-year rate, potentially disrupting the current bull run in the equity market.
Because of these market influences, in my opinion I expect the first half of 2021 to be turbulent as the market tries to grapple with inflation fears and higher rates. In my view, I suspect the second half of 2021 will be a recovery phase for the equity market, as inflation readings subside.
These are excerpts from Mott Capital’s 4th Quarter 2020 Letter published on Jan. 29.
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