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A Policy Error Could Trip Up Stocks - Hello Friends as always i would invite you to join and Promote one of the world's premier top rated investment companies and pioneers in alternative assets: market investment in and purchasing of alternative asset classes including gold, precious metals, Bitcoin and other cryptocurrency for direct purchase investors, the vast US market of IRA, 401k and other retirement account holders, the Canada market for RRSP and TFSA holders (precious metals), high net worth individuals and families (HNWI), and more. Mutl-trillion dollar potential market with one of the highest paying affiliate programs in the world.

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Broadly investors have enjoyed strong returns in stocks over the past two years, the S&P 500 Index returned 31.5% in 2019 and 18.4% in 2020. Last year's return occurred in an environment where earnings for S&P 500 companies is expected to equal $133, down from $157 in 2019. This move higher in stocks at the same time earnings declined has pushed large company stock valuations to levels where one might say they are priced for perfection. One way to look at stock valuations is reviewing a measure called the Rule of 20 which states that stocks are fairly valued when the inflation rate plus the price earnings ratio of the S&P 500 Index equals 20. As the below chart shows this measure currently equals 23.4. If one uses the P/E based on the index's 2022 earnings, the measure equals approximately 20.4.



A number of various stock market valuation measures do look extended. The ones that do not looked extended are ones based on interest rates and it is true stocks can trade at higher valuations at lower interest rates, all else being equal. Because a company's future earnings are worth more when discounted back to the present at lower interest rates, this justifies stocks trading at higher P/E's. As seen in the below chart though, interest rates are trending higher. The yield on the 10-Year U.S. Treasury has moved up from the .50% level last March to a yield of 1.10% now.


This move higher in the 10-year Treasury is taking place at a faster pace than the increase in short term interest rates. This has resulted in a steepening of the 2y/10y yield curve.


One tailwind for stocks has been the low interest rate environment. As an investor, psychologically, it can be difficult to lock up one's money for ten years in a 10-year U.S. Treasury that only yields 1.10%. This environment has created a market that some strategist refer to as a TINA market, There Is No Alternative to stocks. One important observation in the above yield curve chart is the market has a history of pulling back when the curve steepens. One difference at this point in time is the fact the absolute level of interest rates is low, i.e., near zero; thus bonds providing limited competition for stocks.

What can occur in this backdrop is a policy mistake by the Federal Reserve or politicians in Washington, D.C. This fact may be weighing on the Economic Policy Uncertainty Index as it remains near a historical high, excluding the spike higher in the February/March period last year. The Uncertainity Index measures policy-related economic uncertainty that includes three types of underlying components:
  • "One component quantifies newspaper coverage of policy-related economic uncertainty."
  • "A second component reflects the number of federal tax code provisions set to expire in future years.
  • "The third component uses disagreement among economic forecasters as a proxy for uncertainty. 

It is worth noting that policy can trip up the market in the short run. Higher tax rates will take money out of the private sector and the productive part of the economy. Additionally, a higher corporate tax rate reduces after tax reported earnings and this pushes up the valuation of stocks. From a positive standpoint, so long as economic growth remains favorable, any potential headwind due to policy changes may be temporary. With the vaccine rollout underway and the likely positive impact from increased immunizations, this can minimize some of the policy changes. Absent the February/March equity correction last year, the equity market has experienced strong returns the last two years. Investors should not be surprised to see some downside volatility; however, the economic underpinnings remain mostly favorable and should carry over to favorable equity results in the coming year.

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