The U.S. stock market has been on a tear of late, rising 56% in value, or $18 trillion, in the last year. Two-thirds of the gain came in the six months since October. Surging stock values mirror last spring’s rapid plunge, leaving many feeling elated, unnerved, and anxious. Are expectations for the world ahead justified and fairly factored into stock prices? Or is the bull run reflecting unrealistically high hopes?

A Pretty Penny

In our view, valuations are full. By most metrics, we see stock values at high levels. Just look at the value of U.S. stocks at $48 trillion compared to our $22 trillion economy (Chart A). At 2.2 times its size, the stock market is more than double the value of the entire economy — a record. This suggests that prices contain a set of bold expectations about the future.

Chart A

Another example that shows how valuations are full is through a simple trend line. Chart B shows the market with a computer-drawn long-term trend line. The solid orange line shows the S&P 500 from 1946 to today. The index now stands near 4,181, above the middle trend line, suggesting an elevated price. For further reference, we’ve had the computer fit high and low trend lines as well. This long perspective indicates the market might be a little on the expensive side.

Chart B

What about comparing stocks to bonds? Chart C below shows the earnings yield on the S&P 500, a proxy for large stocks, in relation to the 10-year U.S. Treasury Bond yield. The earnings yield is a measure of value compared to earnings, calculated as expected earnings divided by price. By this measure, stocks appear to offer a better value than Treasury bonds. The trouble with this perspective is that stocks may still be pricey because bond yields are so low.

Chart C

Reshaping Government

Even though valuations appear full, growth expectations in the near term should continue to ramp up, helped along by a surge in government spending. Consider that the federal government spends roughly $5 trillion yearly. This amounts to about 20-23% of the economy and does not include state or local government spending (Chart D). As recently as 2018, growth in federal spending was near 3%. In 2019 outlays grew 8.3%, and in 2020 they rose 12.5% as the pandemic hit.

Chart D

The Biden administration hopes to continue along this spending path. Nearly $6 trillion of spending has been enacted or proposed since January. The $1.9 trillion American Rescue Plan (ARP), the $2.3 trillion American Jobs Plan (AJP), and the $1.8 trillion American Families Plan (AFP) are the three plans designed to reshape the economy post-COVID-19. If implemented, these plans will accelerate a shift by the government to become a more significant consumer of goods, labor, and services. This shift can add to already pent-up demand from the private sector.

Of course, the Federal Reserve has played a major role in providing liquidity and driving ultra-accommodative monetary policy alongside a historic fiscal impulse. The one-two punch of potent monetary and fiscal policy has had a dramatic impact on the pandemic economy, and will likely have ripple effects (ie. taxation, inflation, interest rate effects) long after the pandemic passes into history.

Pent-Up Demand

The most crucial reason growth should ramp up is because vaccinations can uncork pent-up demand. This is already seen in reports of Americans expecting to return to pre-pandemic life soon. And not only is there an appetite to take vacations, go to restaurants, and get out, but there is cash to fund these activities.

Consider last week’s report on household income and spending (Chart E). The blue line on top shows how total disposable income actually surged during the pandemic. Much of this comes from federal payments and supports to aid with the pandemic. We now see that disposable income, including federal support payments, is $18.2 trillion over the past 12 months. Before the pandemic, this number was $16.4 trillion, for a $1.8 trillion increase.

Chart E

But this is not all. Just as total incomes rose, spending slipped. The rate of total spending declined to $14.3 trillion from $14.7 trillion, for a $400 billion falloff. Because incomes rose $1.8 trillion and spending fell $400 billion, total household savings soared to $2.2 trillion (Chart F). On top of that, rising asset values lifted U.S. household’s net worth $12.1 trillion in 2020, adding to the $12.7 trillion gains of 2019. As vaccinations are rolled out, many Americans are well-positioned to step up spending.

Chart F


So it is clear that while valuations appear full, there is reason to believe that near-term growth expectations should prove very powerful for two reasons. First, government spending is surging. But most importantly, there is enormous pent-up demand (and money to spend) for Americans looking to get out and about.

Is the market right in assuming that the changes at hand will meet lofty expectations? Only time will tell. For now, we must remain realistic about the future and what today’s high prices imply. A focus on flexible, high-quality companies remains especially important, as does a set of reasonable expectations about future returns from today’s starting point.

Kevin R. Caron, CFA
Senior Portfolio Manager

Chad Morganlander
Senior Portfolio Manager

Matthew Battipaglia
Portfolio Manager

Steve Lerit, CFA
Senior Risk Manager

Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income

Rick Marrone
Senior Portfolio Manager
Municipal Fixed Income

Suzanne Ashley
Internal Relationship Manager

Eric Needham
Director, External Sales and Marketing

Jeffrey Battipaglia
External Sales and Marketing


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