Party Like There's No Tomorrow!

After listening to the lyrics of “Party Like There’s No Tomorrow,” I think it might be a more fitting theme song for our current milieu than “Party Like It’s 1999.” The former was released in 2008 by an acid-rock band while the latter was released during 1982 by the rock star Prince. The former starts with: “Tonight we’re gonna party like there's no tomorrow / Forget about our woes and drown our sorrows.” The rest of the song is sprinkled with lots of expletives belted out by the nutty band.

While tomorrow will undoubtedly occur on schedule, the Covid-19 pandemic is raging like never before. Yet investors are partying with abandon: The S&P 500 and Nasdaq continue their meltups in record-high territory. On Friday, January 8, they were up 70.9% and 92.4%, respectively, from their March 23, 2020 lows. Previously, I have observed that these two widely followed stock indexes soared 59.6% and 236.7% from their LTCM-crisis lows on August 31, 1998 through their blowoff tops in March 2000—so the Prince song came to mind (Fig. 1 and Fig. 2).

The S&P 500 forward P/E rose to a record 25.7 during the week of July 16, 1999 (Fig. 3). It rose to 22.9 on Friday, January 8. The forward P/E of the S&P 500 Technology sector peaked at an all-time record high of 48.3 during March 2000. It was up to 27.7 on Friday, January 8.

I am still targeting the S&P 500 to rise to 4300 by the end of this year (up 14.5% y/y) and 4800 by the end of 2022 (up 11.6% y/y). I am increasingly concerned that the market could get to those levels much sooner, leaving valuation multiples even more stretched than they are today. That would make the stock market increasingly vulnerable to a meltdown. In any event, the bull market stampede has been trampling not only the bears but also even bulls like me since March 23, 2020!

While today’s multiples can be justified by near-record low bond yields, the 10-year US Treasury yield has been trending higher since it bottomed at a record-low 0.52% on August 4 last year (Fig. 4). Here are the new year’s firsts: First thing during the morning of the very first trading day of the new year, the yield rose just above 1.00% for the first time since March 19. It rose to 1.13% on Friday, January 8. The ratio of the price of copper to the price of gold suggests that the bond yield should be closer to 2.00% than to 1.00% (Fig. 5). It certainly seems headed in that direction so far this year.

Now, as in 1999, there are mounting signs of irrational exuberance in the stock market. This time, there are also more signs of ultra-stimulative fiscal and monetary policies than there were back then. The combination could be fueling MAMU—the Mother of All Meltups. Consider the following:

(1) The Blue Wave is coming. Now that the Democrats have control of the White House and both chambers of Congress for at least the next two years (until the mid-term elections), federal government spending is likely to continue growing faster than federal revenues, even if taxes are raised on upper-income taxpayers and on corporations (Fig. 6). The resulting increase in federal debt could be nutty.

The Democrats plan on sending another round of stimulus checks to households. The next package of support is bound to also include hundreds of billions of dollars to bolster the finances of state and local governments. The Biden administration is expected to use early legislation to push hundreds of billions of dollars in renewable energy spending as part of its stimulus and infrastructure measures, potentially including efforts to promote the construction of high-speed rail, 500,000 electric vehicle charging stations, and 1.5 million energy-efficient homes. In the fiscal follies, a billion here, a billion there can add up to trillions very rapidly. (We first discussed the incoming administration's agenda in our July 21, 2020 Morning Briefing titled “Meet the New, Improved Joe Biden.")

(2) The Bond Vigilantes are stirring. While the bond yield was higher in 1999 than it is today, the federal budget was actually in surplus back then (Fig. 7). Over the past 12 months through November, the budget deficit was a record $3.2 trillion. The Fed has helped to keep bond yields down by purchasing $2.4 trillion in Treasury securities over the 12 months through December (Fig. 8).

Those purchases have been concentrated in the longer end of the yield curve more so than in the past (Fig. 9 and Fig. 10). That certainly explains why the bond yield remained below 1.00% during the second half of 2020 even as the economy staged a V-shaped recovery.

However, the Bond Vigilantes are starting to stir. If they succeed in pushing yields higher, stock investors might have second thoughts about the nutty idea that even higher equity valuations are justified. Then again, I can’t rule out the possibility that the Fed would do something nutty like officially adopt a policy of yield-curve targeting to keep a lid on the bond yield. The Bank of Japan’s monetary madness has included doing that since September 2016. If the Fed started to officially target the bond yield, the result would almost certainly be a 1999-style meltup.

(3) The virus is mutating. What could possibly go wrong, causing the meltup to be followed by a meltdown? In my forthcoming book, The Fed and the Great Virus Crisis, my central theme is don’t fight the Fed when it is fighting a pandemic. That worked well in 2020. In 2021, investors need to have the vaccines win the world war against the virus (WWV) and its mutant variants.

While we humans have been celebrating the end of 2020’s annus horribilis, anticipating that 2021 will be a better year for humankind, the virus couldn’t care less. It continues to party like its 1919, which was the second year of the much deadlier Spanish flu pandemic. The near-term outlook on the health front is discouraging, but hopefully the tide of WWV will change meaningfully in our favor in coming months as more of us get inoculated.

Blue Wave Makes a Splash in DC. Will Joe Manchin Be 'Senator Gridlock'?

The Blue Wave made a big splash as Tuesday’s Georgia election results, reported late Wednesday afternoon, showed that both of the state’s seats for the US Senate were won by the two Democratic candidates. A tsunami of socialist policies implemented by progressives in the Democratic party is now likely. A Blue Wave led by the incoming Biden administration, unimpeded by gridlock, certainly represents a radical regime change from the Trump administration. It is likely to be much more radical than the regime change led by the Obama administration. That’s because the Democrats in Congress are much more radical in their left-leaning political views than ever before.

The Democrats’ win in Georgia could be bad news for entrepreneurial capitalism. It could also be bearish for the stock market if the radical regime change causes a recession. That’s unlikely to be the case in 2021. Granted, the 10-year US Treasury bond yield pushed above 1.00% at the start of the week on preliminary news that the Republicans lost one of the two contested elections. I previously argued, even before last year’s elections, that the yield would be closer to 2.00% than 1.00% but for the Fed’s intervention in the bond market.

My analysis was based on the strong post-lockdown rebound in economic activity and the swelling post-CARES Act federal budget deficit rather than on a prediction of a regime change in Washington, DC. Now that the Blue Wave has prevailed, government spending will continue to boost economic activity, and federal deficits will continue to mount. And, most importantly, the Fed is likely to continue to buy notes and bonds in an effort to keep bond yields from rising too rapidly.

In other words, the Fed is likely to enable our deficit-financed government to get bigger under the Blue Wave regime. The Clinton administration was famously checked and balanced by the Bond Vigilantes. The Fed is implicitly assuring the incoming Biden administration that monetary policy will keep them buried as much as possible.

Now consider the following related observations about the stock market:

(1) Socialism isn’t necessarily bearish. Significant declines in stock prices are caused by recessions, not by socialist regime changes, unless they are so radical that they cause a recession. Socialism may be bad for entrepreneurial capitalism, but it provides fertile ground for crony capitalism. That’s as long as it doesn’t lead to communism. Under socialism, private property remains mostly private. Under communism, there is no private property; everything is owned by the state. In either system, the government gets bigger. Under socialism, the ruling regime enacts more laws and regulations that force businesses to manage their affairs increasingly to satisfy their socialist overseers rather than their capitalist shareholders.

(2) Betting on crony capitalists. In other words, making deals with the government matters as much as or more than competing in the market. That’s the fundamental nature of crony capitalism. Businesses become bigger and more politicized as the government gets bigger and more radicalized.

That’s not necessarily bearish for the stock market. However, it does mean that assessing the impact of government policymaking on business becomes as important or more important than traditional analysis of company fundamentals. Spreadsheets for individual corporations need to include columns for the number of lobbyists employed, percentage of business done with the government, cost of regulation, and so on.

(3) And the winner is ... Previously, in my November 2, 2020 LinkedIn newsletter titled “Gridlock Is More Bullish Than Blue or Red Waves,” I observed that gridlock tends to be more bullish for stocks than a united government. I analyzed the performance of the S&P 500 under unified and divided government since FDR took office (Fig. 1). I calculated the percentage increases in the index from January-through-December periods during the two alternative regimes. I found that during the previous six Blue Waves, the S&P 500 increased 56% on average. During the previous three Red Waves, the index rose 35% on average. During the seven periods of divided government, the S&P 500 rose 60% on average. This suggests that gridlock is more bullish than the two unified alternatives, which are also bullish, but less so, with Blue Waves more bullish than Red Waves.

So not surprisingly, on Monday, stock prices fell because the Blue Wave is coming. Yet on Wednesday, they rose because the Blue Wave is even more likely to come! Go figure. While gridlock was the loser in Georgia’s elections on Tuesday, the winner will surely be $2,000 stimulus checks. That's probably bullish for the economy and the stock market during the first half of 2021.

(4) Meet the other Joe, again. Perhaps investors figure Senator Joe Manchin (D-WV) will defend gridlock to the death. We first introduced him to our subscribers in our November 16 Morning Briefing. We wrote: “If the Democrats pull an upset and get both seats, Joe Manchin could be the most important person in America. He is the Democratic senator from West Virginia. He is viewed as a conservative Democrat and has championed bipartisanship.

On Monday, November 9, Joe Manchin was interviewed by Fox News. He said: “50-50 [control] means that if one senator does not vote on the Democratic side, there is no tie and there is no bill.’ He added: ‘I commit to tonight and I commit to all of your viewers and everyone else that’s watching, I want to allay those fears, I want to rest those fears for you right now because when they talk about, whether it be packing the courts or ending the filibuster, I will not vote to do that.’

“He continued saying that the ‘Green New Deal’ and ‘all this socialism’ was ‘not who we are as a Democratic Party.’ He remarked: ‘We’ve been tagged if you’ve got a D by your name, you must be for all the crazy stuff and I’m not.’”