April 14, 2021

Bill Miller 1Q 2021 Market Letter

After rising 5.7% in the first quarter of 2021, this long bull market has continued its advance, adding almost 5% more to the S&P 500 Index in the first two weeks of April alone. In my opinion, there is very little standing in the way of the market moving higher, perhaps substantially higher, this year. My concern is not that the market is too expensive or that rising interest rates at the long end, if they continue, will put pressure on valuations, or that new supply via SPACs and IPOs will drain demand from the broader market, or that inflation will prompt the Federal Reserve to tighten sooner than the market anticipates. My concern is that the market goes up far more than even ardent bulls expect, making the vast majority of stocks unattractive even for those with much longer time horizons than the typical market participant. I don’t think we are close to that yet since we can find plenty of stocks out there that look quite attractive even on conventional valuation metrics such as price/earnings ratios. Just to be clear, after a secular bull market that began in March 2009 and has continued for more than a decade, there are also plenty of names that appear overpriced even if optimistic assumptions prove true.

Recasting the market in the always useful framing from Sir John Templeton, who said that “bull markets are born in pessimism, grow on skepticism, mature on optimism, and die in euphoria,” I think we are in the optimism phase for most stocks, with euphoria breaking out in some areas. What is so unusual is that a year ago in late March the market was collapsing under the weight of pessimism about the impact of the pandemic on the economy. Some observers, who assess markets mechanistically, believe the bull market ended when stocks declined more than 20% last year and a full-on bear market was underway when stocks declined more than 30%, and that now we are in a new bull market. I don’t find such scholastic distinctions all that useful. With vaccinations, especially in the US, proceeding rapidly and those most at risk, those over 65, now mostly vaccinated, the pandemic’s danger appears waning and people are beginning to plan for a return to some kind of normalcy as the year progresses.

The economic experiment now underway – namely massive fiscal and monetary stimulus being injected into an economy that is clearly expanding, with most economists projecting real growth this year that will be the strongest in a generation – is one that is generating consternation among some, such as Larry Summers, and unconcern among others, including Fed Chairman Powell and Treasury Secretary Yellen.

Who is right? The answer is nobody knows. We will just have to watch as events unfold, the same as we have to do with all forecasts about an uncertain future. Summers, who arguably knows as much as anyone about how the economy functions, puts the probability of the experiment working out well, at only 1/3. Despite his deep economic expertise, his forecasting ability does not appear to be substantially better than anyone else’s ability when it comes to discerning the path of critical economic variables, and the same applies to Chairman Powell and Secretary Yellen. It is worthwhile remembering that neither the Fed nor the Council of Economic Advisers to the President, has ever forecast a recession, yet they have been regular features of our economic history.

What we do know is that the Fed has been clear that more accommodation is necessary and that tightening is off the table until realized inflation exceeds 2% for some unspecified period of time and until the economy is at full employment. None of that is in view now, so the risk of the Fed ending the bull market by over-tightening is remote. With forecasts of economic growth being raised, earnings and cash flows are also likely to be higher than expected, providing additional support for stocks.

The main risk to this bull market, barring some exogenous event, is that stocks get too expensive, as they did in 1999 and early 2000, leading to the market generating no returns for a decade. It is also worth remembering that valuations by themselves did not end that bull market. Fed tightening did, just as it did in 1987, culminating in a crash. Some stock market models are flashing yellow, indicating caution at these levels. I am reminded of the aphorism attributed to the eminent statistician George Box, who said “all models are wrong, but some are useful.”

The models that show the market is overvalued are not wrong with respect to their parameters, but they are not useful, in my opinion, because their parameters do not capture the complexity of what drives markets. Market or economic forecasts are forecasts not of variables ordered in particular ways, but forecasts of behavior.

A year ago, the collective psychology of the stock market was fear. Now it is optimism grounded in solid economic growth, low inflation, plenty of liquidity, rising earnings and cash flows, and 10-year interest rates that still provide no real rate of return compared with the inflation the Fed wants to engineer.

The path of least resistance for US equities remains higher.

Bill Miller, CFA
April 11, 2021
S&P 500 4128.60

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