Are we in a bubble?

FANMAG does line up with historical bubbles (see chart below) like Japan, Tech stocks, and Gold. But the rest of the market is not nearly as stretched. Additionally, FANMAG are far less speculative companies than the famous Tech bubble high fliers. My favorite “bubble” question chart (chart 2), strip out FANMAG and the fictitious S&P 494 looks much less overdone. This chart also explains U.S. dominance as well as the struggle that active managers have faced.

Should I just own Apple and call it a day?

Apple is a fine and innovative company. It is one of the biggest holdings in many of our clients’ portfolios. But the history of owning the largest company in the index is poor. Almost definitionally, the point where you become the largest corporation in the world is a point of extreme optimism. The chart below shows that owning the biggest company alone has drastically underperformed owning the rest of the market.

Hasn’t the market rally divorced from underlying fundamentals?

The market tends to move AHEAD of improvement in fundamentals. The first chart below shows us that the initial phase of a bull market tends to be led by expanding P/E ratios and earnings tend to come through 3-4 quarters after the bull market begins. Consensus analyst estimates project a major earnings recovery beginning Q1 2021. The second chart goes on to show us that the market typically peaks on PEAK earnings, not earnings that are likely troughing and recovering.

Should I just step aside and wait until the election is over?

Oh boy, there is a lot to unpack here! First, we have to admit that market timing, as in an all-in, all-out approach, is supremely difficult. Additionally, the first chart below shows us that investing is generally a gut wrenching experience. In fact, the market has spent roughly 75% of the time either in a bear market or recovering from a bear market. And when you feel like the coast is clear (i.e. the market is at new all-time highs), returns are about half that of when the market is recovering bear market losses. Owning stocks will test your fortitude! Unfortunately, that is especially true in an election year. The second chart tells us that, historically when a Republican incumbent has lost, the market has been weak before and following the election. But it also tells us that when an incumbent Republican has won, the yearend rally can be very strong. Polling suggests that this is going to be a tight election. But Trump’s polls have gotten much better and have been tracking coronavirus trends tightly, which have also been meaningfully improving. And even if Biden wins, the third chart tells us that yearend losses have historically been reversed in the following year. Long story short, the market will react quickly and get on with life once we know the outcome.

So you’re saying this election won’t matter?! You’re crazy, this is the single most important event in American, nay, mankind’s history!!!

Don’t hear what we’re not saying. This election does matter to the extent that the policies influence the macro backdrop in which different industries are operating. But we just don’t know what Biden’s actual policy mix will be until he’s in office and we see what the congressional make up looks like. He’s currently proposed raising the corporate tax rate from 21% to 28%. Back of the envelope math implies a -12% hit to earnings. But the effective tax rate is always lower than the stated. If we assume the effective tax rate goes from 17.7% (current) to 21%, EPS drops -4.2%, not so bad. On a granular level, Biden’s policies could end up “reflationary/inflationary.” Some things that would benefit could be cyclical Value stocks, yes even Energy despite the threat of regulation. As well as international stocks, commodities, and muni bonds. The final slide is a bunch of stats under different political mixes historically. Note under a Dem president, Dem congress, stock returns have been solid, nominal economic growth has been strong, inflation has been high, bonds have been somewhat weak, and the dollar has been weak as well. Those are trends that could quite easily develop in the next 4-5 years, regardless of the political mix but a D/D split could speed them along.