New Highs

May 27, 2021
Dow: 34,465

The first quarter earnings reports continued to provide upside surprises as the economy expands and the COVID-19-based restrictions are eased. The average earnings surprise for the S&P 500 has been near 20% for the last four quarters, and the average upside surprise to sales for all S&P 500 companies in the first quarter was 4%, the highest upside sales surprise of the recovery. Every sector of the index delivered positive sales and earnings surprises. These strong results have allowed the index to gain almost 6% so far in the second quarter, equaling the 6% gain in the first quarter.

As we have discussed before, the areas of the economy that were more productive were less affected by COVID-19 than the sectors of the economy that are less productive, namely the leisure and hospitality sectors. As a result, the economy has recovered to nearly the same level of GDP output that it had prior to the decline, but has done so with a level of employment that is only 95% of pre-COVID-19 employment. This higher level of productivity is good for investors, good for those who remain employed, and good for the economy as a whole. Higher wealth stems from increased levels of productivity. Higher wages also stem from increased productivity, although a higher level of skills will be required of the employee in exchange for the higher wage. A higher wage mandated by the government will result in lower levels of employment if prospective employees do not possess the required skillset to offer in exchange for the higher wage.

Different sectors of the market have been going through stealth corrections and consolidations in 2021, even as the S&P 500 moves towards new highs. The largest drawdown peak to trough for the S&P 500 this year is about 4%, and it has happened twice. Looking at several indexes that represent other areas of the market, the Russell 2000 Small Capitalization Index fell almost 10% in just seven trading days in March. The NASDAQ Composite Index fell over 10% in three weeks during the first quarter, and dropped 8% in the two weeks ended May 12th. The Philadelphia Semiconductor Index fell over 14% during a three-week period in the first quarter, and fell over 13% in the five-week period ended May 12th. These rolling corrections in different sectors of the market can go largely unnoticed, and they are a healthy way to limit the frothiness in some sectors while allowing the overall market to remain in an uptrend. One reason the S&P 500 has not had a correction of 5% so far this year is that the index contains companies that have benefitted during the period of COVID-19’s heaviest economic impact, but can also benefit as the economy moves back towards normalcy. Even with large tech companies making up a significant portion of the index, the S&P 500 has proven its resiliency.

We have seen over the last five weeks that Bitcoin and other crypto-currencies are not a one-way trade. While Bitcoin is still positive for the year, it had a 24% decline during mid-January, and was down almost 50% from its mid-April high through last weekend. Some may find it ironic that the pseudo-currency marked a high on April 15th, the day tax payments are usually due in the U.S. The jury is still out on whether Bitcoin can deliver on any of its promises as a secure, valid currency broadly accepted in exchange for other goods, a store of value, and an inflation hedge. Due to the extreme volatility and drawdowns, it does not appear a reliable store of value. This volatility causes it to also get a failing mark so far as an inflation hedge. Have Bitcoin price movements been at all correlated with longer term changes in inflation? No. It has also been hailed for its benefits of privacy and anonymity. These features also have their downsides, as funds are very difficult to track and are the accepted method of payment for some forms of criminal activity and corporate blackmail. Those crypto backers that utilize the new exchanges for trading and investment are sacrificing most of the privacy and security benefits in exchange for convenience. Will the original benefits win out in the long run? We have a long way to go and there will be many twists and turns along the way, including environmental concerns over the carbon intensity of mining and processing Bitcoin.

Random thought: “For greater privacy, it’s best to use bitcoin addresses only once.” -Satoshi Nakamoto, presumed alias used by the founder of Bitcoin