Here it goes. I have no idea what the stock market will do in 2021. The fact that some areas of the stock market soared higher in 2020 makes perfect sense, and what will eventually happen in 2021 will make perfect sense as well, explains Nell Sloane of Capital Trading Group.
If stock prices go up, it’s because more people wanted to own stocks. If they go down, fewer people wanted to own them. But what about earnings? And vaccines? And company debt? Blah, blah, blah. Doesn’t matter.
Apple (AAPL) had record revenue in their last fiscal year. People needed to set up home offices and Apple sold a lot of watches. According to their latest financial report, Net Income grew by…3.9%. That increase requires a lot of watches (and service contracts). Let’s pretend an analyst predicted this net income increase perfectly and somehow knew that Apple would end up buying back one billion of its own shares. This would result in a prediction of about a 10% price gain. But the stock price increased by 99.4% in that timeframe. Did a 3.9% increase in net income cause the stock price to double? Uh, no. So why did it go up that much? Because more people wanted to own it. Is there a mathematical justification? In other words, is there anyone on earth who can legitimately claim they “knew” Apple stock would do that?
Math would have predicted somewhere in the 4%-10% range. The other 90% happened because sometimes that’s what happens. It’s not predictable, but it makes sense. More people wanted to own the stock so now it’s more expensive.
Jumping on the Bandwagon
Is it too late to buy Apple? I don’t know (more brutal honesty). Was it too late when it was up 50%? Apparently not. For people who bought Apple last August and lost 17% of their money within a month it was too late. The point here is that stock prices, for the most part, are not driven by factors that can be predicted, despite what analysts, news reporters, or anyone who bought Apple or Tesla (TSLA) says.
As another example, Intel’s (INTC) net income in the first three quarters of last year rose 6.3% compared to 2019. Pretty respectable. Better than Apple in fact. In the same timeframe, Intel stock dropped 13.5%. That’s not math. It’s supply and demand.
Forecasts vs. Reality
Things that can be forecast, like a company’s earnings or profitability, can sometimes influence the stock price, but what ultimately determines a stock’s price is the balance of buyers and sellers on any particular day, or week, or over a year. This is mostly driven by investor emotion and is therefore, not predictable and certainly not repeatable. It’s exciting, though, because it’s a gamble with sometimes a big payoff. Investments exist that do tend to follow math, but they will rarely return more than 10% in a given year.
2021
My intent is not to start the year off on a down note, but I think it’s important for people to head into this year with their eyes open with respect to the market. There are still some “experts” saying this is a great time to buy, but they always say that. Maybe there is still some room for the market to go higher as the Covid vaccines are rolled out, and there are always areas of the market that can be buying opportunities, but I think a ton of people with new Robinhood accounts have fallen into the trap of thinking investing is easy and the market is their friend. Historically speaking, the market is out of whack, and when the market gets out of whack, it tends to return to whack eventually.
Warren Buffett, one of the best investors of all time, has a favorite indicator that is often called the “Buffett Indicator.” This indicator takes the value of the entire US stock market and divides it by the Gross Domestic Product (GDP). This tells us how expensive stocks are relative to what companies are producing. When stocks are cheap relative to GDP, long-term returns tend to be very good (8%-10%). When stocks are expensive, long-term returns tend to be crappy (a technical term meaning “below most investors’ expectations”). Notice that most of our assumptions about long-term stock returns require a “cheap” starting point. Stocks have been getting steadily more expensive since 1950, so the value of the Buffett Indicator for what is considered to be a fairly valued market is always trending higher. A “cheap” market today would have been considered an expensive market in 1950, or even 2000, so we need to look at where the market value is relative to this rising trend line. On Dec 30, the total US market value was $46.5 trillion and estimated GDP is $21.7 trillion, so the Buffett Indicator is 214% (according to Corporate Finance Institute).
Based on the Buffett Indicator trend line, a fairly valued market today should have a market-value-to-GDP ratio of around 120%. As I mentioned, today’s value is 214%, or 78% higher than the trend line. It has only come close to that once before, at the peak of the dot-com bubble, when it hit 72% above the trend line. At the bottom of the financial crisis, the market value was 46% below the trend line and stocks have done great since then, although it took massive amounts of stimulus to accomplish that. This indicator would suggest that the massive debt we are handing off to our grandchildren did not necessarily help the economy that much, but it certainly helped the stock market. The Buffett Indicator isn’t perfect and there are multiple ways to calculate it, but there’s not a lot of argument that its conclusion is wrong. Stocks are expensive. GMO Advisors is therefore predicting an average return of -3.0% for US stocks over the next seven years. Guru Focus, an analytic service, predicts an eight-year average of -2.2%. Does this mean stocks will lose money over the next seven-eight years? No, stocks rarely obey the models perfectly. But stock investing will probably not be easy over the next decade, and the stock market is definitely not your friend.
Learn more about Nell Sloane by visiting Capital Trading Group
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