Free Money:
The majority of citizens who had never lost a job during the pandemic, received two tax-free stimulus checks in the first few months of 2021. This created one of the greatest booms the world had ever seen. This second round of stimulus in 2021 was like pouring gasoline on a fire. So, free money was either spent, invested, or speculated on with meme stocks (shared investing idea imitated by others). During the year, we saw each of these actions play out with a rippling effect across the economy and markets.
Inflation:
The American consumer spent. Retail sales surged 22% above pre-covid levels in just 15 months (January 2020 – April 2021) – more than the sales growth in the previous 5 years combined! Supply chain shortages, in addition to consumer demand, reminded us of the classic definition of inflation – “too much money chasing too few goods”. Here are a few examples of price increases from the December CPI (Consumer Price Index) report: Fuel Oil: +59.3%; Gasoline: +58.1%; Used Cars: + 31.4%; Gas Utilities: +25.1%; Meats/Fish/Poultry/Eggs: +12.8%; New Cars: +11.1%; Overall CPI: +6.8%; Electricity: +6.5%; Food at home: +6.4%; Food outside home: +5.8%; Apparel: +5.0%; Transportation: +3.9%; and Shelter: +3.8%. U.S. inflation rose from 1.4% at the beginning of the year to an incredible 6.8% at year end – the highest rate seen since 1982!! The consensus thinking is that inflation is understated. The largest single component of the CPI is shelter, and that figure was stated as +3.8% – no way. Rents in the US rose 18% (the highest ever) while home prices rose 19% (also the highest ever).
In addition, increasing pressure on consumer prices came from rising wages – US average hourly wages increased 4.8% in the last 12 months. Almost all major corporations have announced pay hikes and increased benefits for their employees – Amazon, Walmart, McDonalds to name a few. The number of job openings in the US currently exceeds the number of unemployed people by over 4 million, a record high. Employers had to entice workers back into the work force with increased wages. Yet another factor impacting supply was the percentage of workers quitting their jobs. It hit an all-time high during the year at 3%. The three rounds of stimulus checks allowed people to increase their savings and it afforded them the ability to leave a job they didn’t like or search for a better paying one. Companies – whose biggest expense is labor costs – had to increase pay and benefits. Companies had to choose to either accept lower profits or raise prices of goods and services – passing them on to consumers. So, companies increased prices more than enough to offset their higher costs. Earnings of S&P companies hit record highs in the first three quarters of 2021. Profit margins expanded to record highs as well.
Transitory says the FED:
Even with all the inflationary evidence, the FED stuck to their “inflation is transitory” story line. “Actual” inflation did not matter because at year-end the Fed Funds rate stood at the same place it started the year – 0%. That meant a real inflation adjusted rate of -6.7%, the lowest in history – with the exception of December 1974. In December, they were forced to change. Why were they taking this ridiculous stand? To monetize the skyrocketing debt load and their desire to keep inflated asset prices from going down. The stimulus was paid for, by you guessed it – borrowing. US national debt ended the year at $29.6 trillion, that would be $6 trillion higher than where it was just two years ago. The FED was a buyer of a good deal of that new debt, their balance sheet expanded to over $8.7 trillion, more than double pre-covid levels.
Speculation and Investing:
Easy monetary policy and free stimulus checks, boosted investor sentiment to levels we have not seen since the dot-com bubble – the perfect mix for a mania to take place – and there were many. We will list some of them. Bitcoin rose to over $64,000 by mid-April, more than double its year start. It peaked in November with a market cap of over $1.2 trillion. In early May, meme fueled Dogecoin rose to a market value of $87 billion, higher than 408 companies in the S&P 500. This was an increase of over 11,000% from start of the year. Dogecoin ended the year 78% below its high. SPAC (Special Purpose Acquisition Company) IPOs became the rage averaging more than a billion a day – over their record 2020 issuance by mid-March. Remember the celebrities and famous athletes who were sponsoring a SPAC. During the whole year 613 SPACs came to market – total issuance $162 billion. Including traditional IPOs, this number jumps to $316 billion – the largest we have ever seen by far. The SPAC ETF ended the year down 25% after a 40% decline from its February high. Many individual meme stocks reached unbelievable market values during the year, only to crash by the end (think GameStop, AMC, Robinhood traders). GameStop and AMC were down 60% from their 2021 highs.
The lesson for investors is what happens on the other side of every mania – reality. Nothing could seem more irrelevant in a parabolic, sentiment-driven advance, when market indices are making new highs. We must be in an everlasting bull market. However, looking at the markets last year, one would think that was the case as well. The S&P finished up 29% on the year, hitting 70 all-time closing highs, the second most of any year in history (only 1995 had more). The S&P 500 ended the year only 0.6% below its all-time high, but the average Russell 3000 stock was 36% below its all-time high. Over 60% of Russell 3000 stocks are 20% or more below their all-time highs. Many high-growth favorite stocks of 2020 were down substantially in 2021 – Peloton: -76%; Zoom: -45%; Penn National Gaming: -40% to name a few. With the averages having one of the best years ever, what is the explanation? The indices are weighted by market capitalization, so the largest stocks in the indices have been growing rapidly over the last few years. The top five holdings in the S&P 500 – Apple, Google, Amazon, Microsoft, and Tesla – now represent about 23% of the index. This is the highest concentration we have seen in history. With data going back to 1980, Apple, which is now 7% weighting in the S&P 500, is the largest weighting of any individual stock in the last 40 years. Approximately 90% of the other stocks in the S&P 500 are down 20% or more.
Bond market:
The rise in yields last year led to one of the worst years ever in bonds – (1.5% for Barclays US Aggregate). This was only the second time since 2000 that the index posted a calendar year loss and the fourth time since data began collection in 1976. The Bloomberg Barclays US Treasury Index returned -2.32%. This is the fifth worst year on record (data goes back to 1973). With inflation heating up and yields pretty much pinned at zero, the 2-year note saw its worst total return on record. The -0.58% total return was the first yearly loss since collection of date started in 1973.
Commodities:
In 2021, the commodities rally was fairly broad based. Excluding precious metals, commodities had their best year on record. The data going back to 2001 showed the Bloomberg Commodities Ex-Precious Metals Index having the best year ever. Some commodity price changes over the last year: Coffee: -+95%; Lumber: +91%; Heating Oil: +61%; Natural Gas: +54%; Aluminum: +49%; Cotton: +42%, Sugar: +17%; Corn: +16% just for a few examples.
So, it was a year of many interesting developments. While we are always optimistic long-term, the uncertainty of our current times, and the inflation we have warned about has appeared with a vengeance. The FED, whose inflation forecast was the worst ever, will be forced to raise interest rates and pull liquidity from the markets as they institute Quantitative Tightening (reducing their balance sheet by buying less bonds). The current fundamentals of the stock market on a historical basis are extremely overvalued to the most overvalued in history based on the indices. The bond bull market of the last 39 years or so, looks to have ended in March of 2020. The good news is that many stocks are trading at better valuations for the first time in many years. As we continually evaluate the many economic, political and market cross currents, we will be looking to take advantage of better valuations as the year progresses.
We appreciate and thank you for the trust and confidence you have placed in Occam Capital® Management, LLC.