ALINE Market Roadmap: “Party Like it’s 1999”

By Aline Wealth Management on December 30, 2021

The song—by the late Prince (no, not Phillip—the one that had his own caricature/symbol) came to mind when I stared at my screen for what seemed like hours embarking on how to put to words a market that words cannot describe. One for the history books for sure! More than 70 new highs on the S&P—phenomenal. So, all good right? I mean what could go wrong….

Well, the reason music came to mind in the first place was because I was reflecting on tops and how they are hard to spot early but seem so darn obvious after the fact. Music and market tops? Remember, back in 1999, when another Prince (this one a major bank CEO) was quoted saying that they would “dance until the music stops”. And stop it did; and with the silence came a slew of oustings and even some criminal prosecutions—all awful stuff. And with it came down the stock market in the US ushering in the “lost decade”.  Lost indeed, as US investors suffered through a decade of a -9% total return starting in 2000 (and that’s despite the Herculean efforts in the last 10 months of 2009 when the S&P leapfrogged 55%). Buying near a market high hurts—a lot.

For those of you who imbibe from the font of American exceptionalism, I get it. But the facts need to be presented and investors forewarned. Things don’t get much better than what we have had in the financial markets since 2009—truly historical and outliers on all charts.

Speaking of charts:

We must remain mindful and as a gut-check, let’s look at another nation that thought they had the globe by the short hairs.

Back in the 1980s, everything was Japanese—cars, artwork, golf, real estate development, sushi (how many sushi restaurants opened in NYC in the 1980s?) and even business management tenets (business management textbooks were being re-written). The Nikkei hit its high in 1989—that’s 33 years ago—and, as evident in the chart below, has still not returned to those levels. Market tops indeed. Could you imagine going into an index 33 years ago and still being underwater (pricewise, that is not including dividends)? Painful—a lost 3+ decades. Can’t possibly happen here though? Well, probably right due to several structural reasons but that does not mean it can’t rhyme.

Source: Factset

Forgive me, I should have started out making sure that this missive finds you and yours well. Very strange times indeed. I didn’t think we would be in this condition again this year. But I hear that is the nature of viruses—they mutate. Fortunately, so do our bodies with their elegant and intricate ballet of protein production that can keep these variants at bay. Or at least, hopefully, minimized. Well, here is a toast to all things science—the true heroes of our time—thank you!

I wonder if we are becoming numb to COVID?

By that I mean that we know it is out there (and we are likely thinking of it every hour) but maybe we are also learning how to live with it?

We seem to be entering a “virus culture” of sorts. And, from my lens, this shift is significant with feedback loops and knock-on impacts that will affect the economy and markets for a while to come. I keep muttering something my Grandfather would always say—maybe it’s from his time in the Depression and WW2 (which were super tough decades!)—“this too shall pass”. Yes, COVID will pass (and we will persevere) but in the shorter term, I am more concerned about the cure than the disease, namely, those knock-on impacts.

Inflation is here and it’s not transitory (as Fed Chief Powell recently told everyone what they already knew). So old 1970-80s playbooks must be dusted off so we can re-learn investing in a new age—or the old inflation-centric age. Port traffic and supply chain shortages have an impact, and it is felt largely in prices—that’s inflation.

Similarly, the ESG movement and the focus on environmentally friendly activities in the fossil fuel sector have had ripple effects also.

The movement has held these sectors accountable to strict guidelines and mandates to protect the earth from their harmful activities. Sounds admirable –but guess what? Without fossil fuels—we die. That’s a simple fact. You cannot just “go off” fossil fuel. However, what the movement is doing, smartly in my view, is holding companies accountable to change. Not immediate but incremental; not talk but action and not tomorrow, now. All good (though we must be on the lookout for the noise that is “greenwashing”). The ripple effect of less capital flowing (for the last 2 decades) into the energy sector, has been less investment in new wells, exploration, and development which of course means less supply and with demand pretty much where it has been (even higher with re-opening pressures)—well you know what comes next—inflation.

Another knock on impact is the fact that since 2009 the Fed has been the force du jour in financial markets. Its balance sheet has swelled, and they are pretty much the buyer of last resort for everything that needs a bid. This creates a little of the “moral hazard” condition in investors’ minds that I worry about. When investors feel as if nothing can go wrong—that the Fed has their back and will make things right—that worries me. Plus, you have many younger, novice investors now “playing the market” as if it was the latest video game on their phones. They are speculating but think they are investing—and are using options in many cases which is high octane risky stuff. Yes, they are dancing while the music is playing but I worry about a stampede to the doors when it stops.

And if you are looking for correlation, check out the following from our friends at MacroMavens (what does this portend for a Fed that is reducing their balance sheet?):

Source: MacroMavens

Volatility, which has increased as of late, is also a by-product of these accommodative (not too much longer?) conditions. Interestingly the volatility has been much more focused on the overvalued—what I called the “hubris stocks”—these largely tech stocks that are small (relative to those everyone knows) but trading (still!) at insane multiples—30x, 40x, even higher to SALES! Not earnings—what’s that? These stocks are money losers (vs the larger, “old tech” which are cash cows). These multiples are to sales—imagine what your local store doing $1 million in sales would be worth if it traded for 30x sales. Wow, that’s what I call a local home run.

Back on Wall Street, these high-flying techs (mostly) have been crushed—and yet for the most part the broad market took it swimmingly. This gives me pause as the overall market has gone to new highs at the same time as the story stocks, the erstwhile darlings, are being crushed. Something is afoot! A change in the air. It could mean that the air is coming out of the bubble slowly and if so, we may be able to defer a major correction. Or it could mean that the soldiers have fallen, and the generals are next. Those partiers who are gleefully dancing without a care in the world –without an eye towards a sitting area so when the music stops—can be left flat-footed. Not our clients. At ALINE Wealth we care for our clients—they are our reason for existing (I wanted to use the popular French term for that)—and as such we have been very aware of these circumstances and have acted accordingly. Speaking with clients, reviewing their policy statements, running different scenarios in their financial plans, and reducing risk in their portfolios.

Here is a slew of charts that illustrate the current stretched conditions in the US as it relates to valuation:

So, what is an investor seeking capital appreciation without undue risks to do?  Well, we see opportunities outside the US—international investing has been a flat trade for nearly a decade hence we see opportunities in both developed and emerging markets. Price matters—and if you look at things empirically –the US markets are wildly expensive vs their international brethren.

We also are finding opportunities in the real asset classes—commodities, precious metals, infrastructure—tangible assets rather than paper assets if you will. These sectors have seen a pickup with inflation at their backs and we expect this to continue.

Finally, the value style looks like it has a long runway of outperformance ahead (overdue since it has been trounced by growth for years). The below graph looks at all the annual (since 1927) value style (factors) performance data vis a vis growth style. Note how the 1999 annus horribilis for value was followed by one of the best—2000 (the crash in tech hurting growth performance and helping, relatively, value). 2020 was even worse for value vs growth than 1999—and you can see the start of a value resurgence in 2021—more to come I believe.

And from a valuation lens—the differences are striking:

Stay with value—energy, financials, industrials—I see it having more room to run.

The bottom line is now is the time to increase allocations to cash and gold. My gut tells me that we will be able to find some great bargains in the first quarter of next year. We have developed a well-thought-out list and themes (see our “4 I’s and 1 V” video and are preparing our portfolios for some generational value opportunities.

Stay well friends and enjoy the New Year festivities—safely. If we play our cards right and science trumps (ahem) nature and this virus-aware period drifts away, we could be dancing in Times Square next year. To a prosperous and healthy 2022!

P.S.

I found this interesting—perhaps this is the takeaway of the ESG movement mentioned above—that companies are being forced to become more sustainable and efficient and in doing so are being rewarded by investors?

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