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December 2020 Economic Commentary

Post Pandemic Exuberance

In the late 1990’s, Fed Chairman Alan Greenspan famously used the phrase “irrational exuberance” in a speech to the American Enterprise Institute. He was issuing a warning that markets looked extremely overvalued as the dot-com boom raged on. Greenspan recognized the dangers of extreme speculation and the impact it could have on inflation and financial soundness. As we all know, the dot-com boom did not end well as the Fed was forced to raise rates to counter the growing euphoria in “tech land”. We find ourselves now in a similar environment of overvaluation and speculation in certain market sectors.

Markets rebounded from lows set in March and then, aided by fiscal and monetary stimulus, continued to new record highs that distanced themselves from underlying fundamentals. As we come out from under the black cloud of COVID with the introduction of a vaccine, we are facing these inflated market prices in what we are calling “Post Pandemic Exuberance”. From cloud computing companies to industrials, we are witnessing price-to-earnings multiples or price-to-sales ratios not seen since the 90’s. Just last week two high profile IPOs, Airbnb and GrubHub, were up over 100% on their opening day of trading even though neither one is profitable. Airbnb now sports a market cap of almost $90 billion, or about half that of Coca-Cola. The forward PE for the S&P 500 Index now sits at 23.4x, eclipsed only by 1998’s 24.3x, versus the historic average around 16x.

When looking at the liquidity driving prices higher, the excesses are profound. For example, one of the impacts of the stay-at-home mandate resulting from COVID has been an explosion in day traders who can use new Fintech sites like Robinhood to trade stocks with significant leverage. Separately, over $74 billion has been raised this year alone through publicly traded Special Purpose Asset Companies (SPACS) to execute takeovers of private companies. On an exponentially higher scale, the fortune 1000 is sitting on $2.5 trillion in cash that will be deployed in part towards capital investment, but even more likely into buybacks. The cash hoard in money market funds stands at $4.5 trillion and outstanding Treasury securities are approximately $6.2 trillion. These instruments offer almost zero return, potentially serving as another significant source of capital that may find itself moving into risk assets. As longtime JP Morgan CEO Jamie Dimon recently told an investment conference audience, “I think Treasurys at these rates…I wouldn’t touch them with a 10-foot pole”. Let’s also not forget the $9 trillion expansion in global central bank balance sheets since March, and the $6.2 trillion in global fiscal stimulus, with much more lined up to help global economies recover as we move into next year. It’s hard to believe we would be throwing around the term “trillion” with such ease.

So where does this leave us from an investing perspective? Very cautious in the short term given the extreme overbought conditions, excessive speculation, and the current return to economically damaging lockdowns. We are significantly more optimistic in the intermediate term due to the tremendous levels of liquidity and pent up consumer demand. Should we see a rapid and effective vaccine rollout, we could be well on our way to further Post Pandemic Exuberance as we move out of a very slow first quarter of 2021 into the rest of the year. Long term, we will have to assess how the corporate earnings recovery catches up with risk asset prices, how labor markets recover from the lockdowns, and what impact excessive deficit spending and rebounding aggregate demand have on interest rates.

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