In a word

In last month’s edition of Exencial Views, I posed this question – “What will be the lasting impact of the pandemic?”  I’d like to try to answer that question.  First, corporate earnings are showing signs of life, with positive surprises outnumbering negative surprises at several bellwethers across multiple industries and sectors.  This is a very important development, and if this trend continues, it could be a key driver of future stock price performance, at least in the near term.  Keep in mind, one of the major reasons for skepticism of a stock market that continues to set new highs is that valuation is getting stretched.  If earnings grow faster than consensus expectations, that argument becomes much weaker.  How are companies able to grow earnings faster than expected despite all the reasons not to expect that to happen, including the lingering effects of the pandemic and overall political dysfunction?  In a word – Resiliency.  Like it or not, there are few forces in the universe stronger than the desire to create profits.  Corporations, at all levels, continually make strategic adjustments to the ebbs in flows of the business cycle and the ever-changing global economic environment.    

Second, we are seeing increasing signs that Merger & Acquisition activity is heating up, particularly in the Health Care sector.  In most cases, increased M&A activity leads to higher stock prices.  With productivity improving and ongoing fiscal stimulus from the federal government, many corporations are flush with cash.  Moreover, with interest rates still historically very low, access to capital for acquisitions is readily available. 

These two factors, better earnings growth and accelerating M&A activity, should support stock prices going forward.  Beyond that, there is one other factor, although it is more difficult to quantify…

In a word – Resiliency…  Neighborhoods and communities, in towns, large and small, across our amazing country are moving forward.  We wear masks to church and the grocery store, and don’t think twice about it.  We social distance when we should but are once again hugging those we love.  We are getting our shots, planning trips previously postponed, and planting gardens.  Just finding joy in normalcy, while accepting that times have changed.  We are reaching out to others in need and worrying less about things we don’t like and can’t control.  And that is a good thing.  In essence, we have adjusted, and we are breaking free of the worst-case mentality mindset that had been pervasive and debilitating to our national psyche and sense of community.  We are reuniting and rebuilding.  Hope has been renewed. 

Perhaps the most important lasting impact of the pandemic is that our country has learned humility.  We were ill-prepared, mislead by experts and politicians, at times stubborn and selfish, and we suffered greatly.  But we learned, adapted, and persevered.  Most importantly, we are slowly putting our differences in proper perspective, and concentrating on how we can unite and work together.  This is happening in families, neighborhoods, and communities.  Eventually, even our political leaders will follow.   

You will be hard pressed to find supporting data in the mainstream media or in never-ending, one-sided political dialogue. You certainly won’t hear about it by listening to the elites, who have long ago lost touch with the heart and soul of America. Nevertheless, I am convinced it is happening. A Renaissance of the soul, perhaps. In a word – Grace.

Meanwhile, despite my unbridled optimism, there are always risks to evaluate and monitor.  For starters, we are keeping a close eye on the yield curve.  I expect it will continue to steepen, in anticipation of higher inflation resulting from profligate government spending and debt accumulation.  If interest rates rise too much too fast, the economic recovery could be at risk. 

In addition, tax rates are going up.  How much and how soon remains to be seen.  Higher taxes will reduce future economic growth potential.  Ultimately, the outcome of the interim election in November 2022 could have a significant impact on the outlook for taxes and economic growth. Finally, there is always the risk that government overreach will produce harmful unintended consequences for the economy and markets. 

Each day, our investment team debates these risks as well as future opportunities.  It’s always a balance between the two. From a macro perspective, a bullish case can always be made. Unfortunately, so can a bearish case. It’s just the nature of how the markets work. In most cases, reality lies somewhere in between. A prudent investor is guided by, in a word – Temperance.

Michael Kayes, CFA