Markets Party Like There's No Tomorrow

After listening to the lyrics of “Party Like There’s No Tomorrow,” I think it might be a more fitting theme song for our current milieu than “Party Like It’s 1999.” The former was released in 2008 by an acid-rock band while the latter was released during 1982 by the rock star Prince. The former starts with: “Tonight we’re gonna party like there's no tomorrow / Forget about our woes and drown our sorrows.” The rest of the song is sprinkled with lots of expletives belted out by the nutty band.

While tomorrow will undoubtedly occur on schedule, the COVID-19 pandemic is raging like never before. Yet investors are partying with abandon: The S&P 500 and NASDAQ continue their meltups in record-high territory. On Friday, January 8, they were up 70.9% and 92.4%, respectively, from their March 23, 2020 lows. Previously, I have observed that these two widely followed stock indexes soared 59.6% and 236.7% from their LTCM-crisis lows on August 31, 1998 through their blowoff tops in March 2000—so the Prince song came to mind (Fig. 1 and Fig. 2).

The S&P 500 forward P/E rose to a record 25.7 during the week of July 16, 1999 (Fig. 3). It rose to 22.9 on Friday, January 8. The forward P/E of the S&P 500 Technology sector peaked at an all-time record high of 48.3 during March 2000. It was up to 27.7 on Friday, January 8.

I am still targeting the S&P 500 to rise to 4300 by the end of this year (up 14.5% y/y) and 4800 by the end of 2022 (up 11.6% y/y). I am increasingly concerned that the market could get to those levels much sooner, leaving valuation multiples even more stretched than they are today. That would make the stock market increasingly vulnerable to a meltdown. In any event, the bull market stampede has been trampling not only the bears but also even bulls like me since March 23, 2020!

While today’s multiples can be justified by near-record low bond yields, the 10-year US Treasury yield has been trending higher since it bottomed at a record-low 0.52% on August 4 last year (Fig. 4). Here are the new year’s firsts: First thing during the morning of the very first trading day of the new year, the yield rose just above 1.00% for the first time since March 19. It rose to 1.13% on Friday, January 8. The ratio of the price of copper to the price of gold suggests that the bond yield should be closer to 2.00% than to 1.00% (Fig. 5). It certainly seems headed in that direction so far this year.

Now, as in 1999, there are mounting signs of irrational exuberance in the stock market. This time, there are also more signs of ultra-stimulative fiscal and monetary policies than there were back then. The combination could be fueling MAMU—the Mother of All Meltups. Consider the following:

(1) The Blue Wave is coming. Now that the Democrats have control of the White House and both chambers of Congress for at least the next two years (until the mid-term elections), federal government spending is likely to continue growing faster than federal revenues, even if taxes are raised on upper-income taxpayers and on corporations (Fig. 6). The resulting increase in federal debt could be nutty.

The Democrats plan on sending another round of stimulus checks to households. The next package of support is bound to also include hundreds of billions of dollars to bolster the finances of state and local governments. The Biden administration is expected to use early legislation to push hundreds of billions of dollars in renewable energy spending as part of its stimulus and infrastructure measures, potentially including efforts to promote the construction of high-speed rail, 500,000 electric vehicle charging stations, and 1.5 million energy-efficient homes. In the fiscal follies, a billion here, a billion there can add up to trillions very rapidly. (We first discussed the incoming administration's agenda in our July 21, 2020 Morning Briefing titled “Meet the New, Improved Joe Biden.")

(2) The Bond Vigilantes are stirring. While the bond yield was higher in 1999 than it is today, the federal budget was actually in surplus back then (Fig. 7). Over the past 12 months through November, the budget deficit was a record $3.2 trillion. The Fed has helped to keep bond yields down by purchasing $2.4 trillion in Treasury securities over the 12 months through December (Fig. 8).

Those purchases have been concentrated in the longer end of the yield curve more so than in the past (Fig. 9 and Fig. 10). That certainly explains why the bond yield remained below 1.00% during the second half of 2020 even as the economy staged a V-shaped recovery.

However, the Bond Vigilantes are starting to stir. If they succeed in pushing yields higher, stock investors might have second thoughts about the nutty idea that even higher equity valuations are justified. Then again, I can’t rule out the possibility that the Fed would do something nutty like officially adopt a policy of yield-curve targeting to keep a lid on the bond yield. The Bank of Japan’s monetary madness has included doing that since September 2016. If the Fed started to officially target the bond yield, the result would almost certainly be a 1999-style meltup.

(3) The virus is mutating. What could possibly go wrong, causing the meltup to be followed by a meltdown? In my forthcoming book, The Fed and the Great Virus Crisis, my central theme is don’t fight the Fed when it is fighting a pandemic. That worked well in 2020. In 2021, investors need to have the vaccines win the world war against the virus (WWV) and its mutant variants.

While we humans have been celebrating the end of 2020’s annus horribilis, anticipating that 2021 will be a better year for humankind, the virus couldn’t care less. It continues to party like its 1919, which was the second year of the much deadlier Spanish flu pandemic. The near-term outlook on the health front is discouraging, but hopefully the tide of WWV will change meaningfully in our favor in coming months as more of us get inoculated.