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Markets near record highs, though valuation concerns loom

January 26, 2021


  • Equity markets continued their impressive rally last week, gaining for the third time in four weeks and touching fresh record highs. The rally was broad-based, though the complexion shifted from recent weeks, with large caps and technology returning to leadership ahead of an important week for earnings.
  • The bears are trying to hang their hat on valuations. While valuations are concerning, they have historically been poor timing mechanisms for market performance. Signs of excess continue to concern investors, with markets at near-record highs on a variety of valuation metrics, including P/E ratios, market cap-to-GDP, cash flow yield and price-to-book. Low interest rates have been used as justification for high valuations, but rates are beginning to move higher. However, continued market performance is reliant on continued easy financial conditions and improvement in earnings. Other signs of extreme optimism include put-call ratios, credit spreads and momentum indicators.


  • A bipartisan group of 16 Senators pushed back against the $1.9 trillion price tag for the Biden administration’s stimulus package, providing too much cash to high-income Americans, while Republicans view the $15 minimum wage as a non-starter. There is bipartisan support for a more modest bill, including increased spending on vaccine distribution. If the administration aims to do a large deal, it will need to do it through budget reconciliation, which requires only 50 votes but is more limited than the traditional path.
  • Economic data reflect an improving picture that remains vulnerable to setbacks. Manufacturing has seen a sharp rebound, with January Markit manufacturing PMI hitting a new record high and existing home sales up 22% from a year ago. Employment continues to lag, with initial unemployment claims stubbornly high at 900k, though continuing claims are at the lowest level since last March. Credit card delinquencies reached record-low levels in 2020, as Americans took advantage of stimulus checks and adjusted their spending habits. High-frequency data points are showing signs of slowing, including retail sales, restaurant bookings and job postings.
  • Earnings season is off to an impressive start, with 86% of companies reporting better-than-expected results, beating estimates by a staggering 22%. Despite the strong performance, the market has not rewarded those reporting, with the average stock performance in the two days before and two days after at -1.2%. This reflects the optimistic assumptions priced into many stocks following a 14% rally for the S&P 500 since election day. The current consensus is for a decline in fourth-quarter earnings of 8% on a 3% drop in sales. This is an improvement from the 12% decline expected at year-end and would result in a 15% decline for the year. The first quarter is expected to return to growth of 14%, with 2021 currently forecasted to grow by 23%.
  • New Covid-19 cases have averaged 167,000 per day over the past week, down nearly one-third over the past two weeks and at the lowest level since November. Positive trends have also been seen in positivity rates, hospitalizations and deaths.

What to Watch

  • A wave of economic data awaits, including consumer confidence on Tuesday, durable goods on Wednesday, GDP, leading indicators and new home sales on Thursday, and PCE deflator, personal income and spending and consumer sentiment on Friday. The Senate will deliberate on the second impeachment of former-President Trump, while the FOMC meeting will be held on Wednesday.


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  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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