Investors Turn Attention to Vaccine Distribution and the Economic Data

By Ketu Desai

As we land into 2021, the backdrop for the equities remains supportive. The amount of stimulus and liquidity is historic. M2 money supply is up 26 percent for the year! There is a combined $7.5 trillion of cash in money market accounts and cash on bank balance sheets. With negative real rates and nearly a 6 percent equity risk premium, investors are subject to TINA (there is no alternative to equities). The Fed at its December meeting continued to commit to $120 billion of QE per month, “until substantial further progress has been made toward the Committee's maximum employment and price stability goals." At Chairman Powell's Jackson Hole speech, he said that the Fed will focus on average inflation targeting, essentially letting inflation run hot. Given this framework, QE and easy financial conditions will be with us for a while, providing support for the equity market. In total, the Fed, ECB, and BoJ expanded their balance sheets by $8 trillion in 2020. It took them almost eight years to do the same after the financial crisis.

Corporate cash is also at a record $2.1 trillion, up 30 percent. The year 2021 is setting up to be strong in corporate activity including M&A, capital expenditures, and shareholder friendly activity such as buybacks and dividends. Goldman Sachs estimates that buybacks and dividends for the S&P 500 will total $1.1 trillion in 2021. One of the biggest beneficiaries of corporate activity will be the banks. Not only will they profit from advising on M&A and new financing deals, but they themselves will return massive amounts of capital to shareholders. Banks are significantly over-reserved, and 2021 will likely see billions in released reserves. Minutes after the Fed allowed the banks to resume buybacks, JP Morgan announced a $30 billion buyback program, amounting to just under 10 percent of its market cap. Similar programs should be announced across the banks. Further, there is already talk that many banks are considering a large special dividend on top of the greater than 2.5 percent dividend yield that you get at most banks. Lastly, banks are one of the cheapest areas of the market, and benefit from rising rates and a cyclical recovery.

While the S&P is in an uptrend, making a series of higher highs and higher lows, the near-term risk is that sentiment appears to be stretched. Measures such as the put/call ratio, Citigroup Panic / Euphoria model, numerous investor polls, and RSI suggest cause for concern. We may see an unexpected shake-out during the first quarter. A shake-out would help refresh the rally, allowing more of the sidelined cash to come into the market. The magnitude of the stimulus and liquidity would likely limit the duration and extent of the shake-out.

One of the biggest challenges that investors will face in 2021 is figuring out how best to hedge their portfolios. With yields so low and inflation expectations rising, the future ability of Treasuries to provide a meaningful buffer to equity volatility and a positive real return seems limited. During the correction in September and October, Treasuries lost money along with equities, this may be a microcosm of future volatility. The historical way of throwing 20-50 percent in fixed income appears on its way to becoming obsolete. Portfolio construction will require more customization, thought, and dynamism. Investors will need to take a serious look at what risks they are specifically trying to hedge, how much equity volatility they can stomach, how much duration and credit risk they feel comfortable with, what the beta is in their overall financial picture, what their personal inflation expectations are, timeframe, lifestyle and capital needs are, etc.… The answers to these types of questions will inform their personal asset allocation and portfolio construction.

Looking forward, investors will turn their attention to the vaccine distribution and the economic data.

Happy New Year!

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com