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Progress, Perils, and Potential Pachyderms

| December 21, 2020

Before continuing the theme of what we’re expecting and analyzing in 2021, let’s first recap the very recent past, which has been rather incredible.

We saw new all-time highs in the S&P 500 (higher than 3,700), deliveries of the first COVID-19 vaccines, and the Electoral College filled in a clear path to inauguration for President-elect Biden. Additionally, the Federal Reserve remained committed to low interest rates, and on a forward-looking predictive basis, many analysts forecast the S&P 500 to be at 4,000 or more in 12 months (not quite as bullish as our recent call of 4,200, but it’s not far off).

A benefit of all this is the market broadening out, which provides several new thematic investment ideas heading into 2021. The question is – are we witnessing a trend or a short-term reversion to the mean?

If it's really a trend, we’ll definitely will see the market continue to drive higher. Further adding to the bullish side is rising optimism about a recovery in labor markets and corporate earnings, which generates positive sentiment.

Still, it would be malfeasance for us not to address the current potential risks.

While Congress has taken care of itself by quietly passing a short-term, stopgap spending bill, there are still many thousands of small businesses closing up permanently as political figures play politics and delay funding for additional COVID-19 relief. And yet, additional closures take place across the country.

Perhaps soon Congress will actually pass the current relief package while also extending the eviction moratorium for another 60 to 90 days. A lot can (and should) happen from a political standpoint in the next three weeks. After all, politicians are the ones forcibly shutting down businesses and people’s ability to earn wages.

2021’s Elephant in the Room?

Simply put, the market is forward-looking, so we need to be as well. Beyond the Main Street issues addressed above, it’s customary every year for Wall Street to solicit professional and retail market participants about what potential future risks they see that could derail markets. Here are this year’s results:

We find it most interesting that the top three concerns are all related to COVID-19 or a vaccine, even with the first vaccines distributed and people being inoculated worldwide. Why do the results of a survey on financial risks focus on the virus and a vaccine, given what’s taken place? It seems to create somewhat of a disconnect.

Make no mistake, we respect the opinions of the survey participants. However, we humbly disagree on top financial risks. For us, the greatest concern on that list is the sixth one down – runaway money supply growth that causes inflation earlier than anyone expects.

The current thinking is that as long as sovereign bonds of investment grade in developed nations continue to yield from 0-1 percent, then central banks like the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China can print unlimited money. All these banks have expressed extreme confidence in their policy statements about their abilities to maintain current levels of money printing. But it's this kind of assured aggressive monetary policy, with literally no historical precedent, that should provide some caution going forward.

The below chart shows the 10-year Treasury yield is currently testing resistance at the 1-percent level. The black line is the 200-day moving average, the blue line is the 100-day moving average, and the yellow line is the 50-day moving average. If the blue line is meaningfully breached by the jagged grey line (the current yield), many automated trading platforms will sell as they are programed to do when certain technical indicators are hit.

Just like when buy programs kick in for the stock market, time and time again the same holds true for bond, commodity, and currency markets. Machines will react when certain levels are breached. If the 10-year bond takes out the 1-percent level, that opens the way for a move to 1.5 percent. While that would still be historically cheap, it would disrupt equity markets in the short term.

Oddly, or maybe not so much, this concept aligns with our discussion last week about Map Signals’ trusty Big Money Index (BMI), which tracks institutional investor activity. The BMI is overbought. To us, from a risk standpoint, this confluence of inflation and an overbought market seems to be the elephant in the room in 2021. And nobody wants to talk about it.

Happy Holidays

Pachyderms aside, in all seriousness, we’d like to wish everyone a happy holiday season. We hope this year in particular brings good cheer and happiness to you and yours.

No matter what holiday(s) you celebrate, we hope they’re safe and full of joy!

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial Services, CoreCap Investments, and CoreCap Advisors are separate and unaf´Čüliated entities.