Well, there you have it. Another trading year behind us that has been quite a ride. The S&P 5001 looks like it will end the year up around 17.5% (FastTrack data). That is incredibly surprising, given that the same index was down over -30% at one point back in March. It seemed a certainty that the economic shutdowns due to the Coronavirus were going to put the economy into recession. But somehow, we avoided that…for now.
Looking ahead to 2021, there isn’t much in the near future that looks negative for the stock markets. Many cyclical patterns suggest it could be another decent year. So, what could go wrong? At the moment there are two items of interest on the horizon that could shake things up a bit.
First, a move back to total lockdown, much like we had in early to mid-2020. There is no doubt that economic damage was done to certain parts of the economy that may never recover. But I remain an optimist in that, while we may not return to the old normal, I believe these hardships and setbacks can lead to new ideas, businesses, and ways of living that we would never have gotten to otherwise. Difficult times can lead to amazing innovation, so that is my hope for the future.
The second item is what I’m keeping in mind the most: the valuation of the stock market (as measured by the Shiller PE Ratio). The current valuation, just over 34, is higher than the peak that preceded the 2008 financial crisis. It is higher than the peak that preceded the great depression in 1929. In fact, the only peak it is not higher than is the one that preceded the Tech bubble burst in 2000.
So, while the market is currently historically overvalued, if it follows the path of 1999/2000, we could see another 50% of upside before things get ugly. But let’s stay positive for now as we put an ugly and exhausting 2020 behind us.
This month’s chart is a snapshot from the Shadowridge data dashboard that we use to get a feel for the current market context. The L/T Trend (Long Term Trend) is positive and stretched 2.51% beyond its average. Generally speaking, this is a big picture positive for the current market environment and the signals can last for months at a time. The Mid-Term Cycle, where we combine money flow and directional momentum, has been leaning negative for a couple of weeks now. Its job is to focus on the probable market direction in the medium term, meaning weeks at a time, and to give us a heads-up as to when to consider being vigilant. Therefore, we are being somewhat cautious going into the new year.
Bonds – the bond markets have had a decent year considering the excessive volatility they also experienced in March. The Aggregate Bond Index AGG is up 7.39% Year-to-Date (FastTrack Data). An especially interesting rebound in the High Yield Municipal Bond market has also been occurring post-election. And High Yield bonds are still moving steadily higher, though only up around 4.39% YTD (FastTrack Data).
This year has been exceptional for us at Shadowridge. Our total assets under management nearly doubled and many of our models (both equity and fixed income) beat their benchmarks while taking less risk.
We also expanded the team to include Will Hepburn and Yvette Zurita when we merged with Hepburn Capital in September. They are both huge assets and an absolute pleasure to work with, enhancing the Shadowridge team in so many ways.
Finally, as we close out 2020, we are spending a lot of time reviewing our investment strategies. What worked? What didn’t? Where can we improve? These questions have already led us to some new and interesting paths to explore in the coming year that I’m excited about. And although these are new ideas, we would never offer something we wouldn’t put our own money into.
Happy New Year, everyone!
1 The Standard and Poor’s 500 is an unmanaged, capitalization-weighted benchmark that tracks broad-based changes in the U.S. stock market. This index of 500 common stocks is comprised of 400 industrial, 20 transportation, 40 utility, and 40 financial companies representing major U.S. industry sectors. The index is calculated on a total return basis with dividends reinvested and is not available for direct investment.
2 Charts are for informational purposes only and are not intended to be a projection or prediction of current or future performance of any specific product. All financial products have an element of risk and may experience loss. Past performance is not indicative of future results.