The S&P 500 and Dow reversed earlier losses to push into slightly positive territory, as investors weighed rising COVID-19 cases in the U.S. and increased restrictions against hopes for an effective vaccine. Cresset Capital's Jack Ablin and UBS's Seth Carpenter joined Seana Smith and Adam Shapiro to recap the trading day.
ADAM SHAPIRO: Let me start with you, Jack, because I'm taking a look at what some people would call the pandemic losers, the airlines. And, right now, going into the close, American Airlines, Southwest, even Delta-- well, Delta's off, a bit flat. But the other two are trading higher. despite The spike in COVID-related cases, is now the time to start picking those losers as potential gainers next year?
JACK ABLIN: Yeah, I mean, now that we have a vaccine and we've sort of at least put a pretty good sense of the timeline on the calendar, I think the vaccine has now taken up or addressed the biggest risk facing investing in these weak companies. And that is, OK, there's a deadline now that things will start getting back to normal.
One of the issues with, you know, investing in these wildly cyclical companies that, you know, are bleeding cash is that we had no idea when things would start to turn around for them. And so, in many respects, equity investors, particularly in these cyclicals, were looking at their equity portfolios like bond investors would look at their bond portfolios, which ones are going to make it to the other side, which ones won't. At least now that we have a time frame, a lot of the risk behind those investments is off the table.
SEANA SMITH: Jared, we're just around a minute from the bell. We saw the Dow come back from negative territory, recovering from earlier losses. That coming on the headlines that we got out about the stimulus. But what led this rebound? And what are watching here into the close?
JACK ABLIN: Well, we are at session highs or near session highs for most of the indices, some decent price action today. I was focusing on a lot of the software names. We had some nice action there. I'll get to that heat map in a second, but let's take a look at the NASDAQ 100.
And we can see the big guys to the left, all gaining nicely. Tesla up 2 and 1/2% for another record high. And here is the software space as we're looking at it. And, if we sort by performance, we could see some names at the top, Twilio up almost 6%, Teladoc, 5%, Coupa, up about 4 and 1/2%, and same for Slack here. And these software names have been a big part of the run up since March and kind of get lost in the shuffle here a lot of times because we talk about the mega caps or some of the flashy semiconductor names like Nvidia, which, by the way, is closing the day up 15 basis points.
ADAM SHAPIRO: All right, it looks like we're going to settle with the major indexes in positive territory. The sectors are doing well. The only laggard seem to be utilities and health care. I want to throw this over to Seth Carpenter because there was news just before we came into this train that the stimulus talks may live again in Washington DC. Is that having an impact, do you think, on the mindset of investors? Or are they saying, that's in the rear view mirror, put a fork in it?
SETH CARPENTER: No, I think it is having an effect. There is still a fair amount of hope out there, at least among my clients, that something will happen. I think people have ratcheted back sort of the high probability event that is going to happen sometime this year. We're not looking for it to happen until next year. But I guess-- I still think Congress is going to be able to come together and get a-- a skinnied down package together at some point.
SEANA SMITH: Seth, [INAUDIBLE] take a look at the data that we got [INAUDIBLE] new jobless claims [INAUDIBLE] for the first time since October. Is there any concern from you and your peers just in terms of this being the beginning of an upward trend?
SETH CARPENTER: Oh, absolutely. Absolutely, there's a concern. And, if you look across states, you can see a clear correlation. The states that had the highest COVID-per-capita cases also see the least progress in job creation, especially in services. And that sort of makes sense. Services is a sector that's been hit hardest by the pandemic. So I think there is absolutely a risk that, if the COVID cases continue to rise, stay out of control, then-- then, sure, I think there is a real threat to the economy.
ADAM SHAPIRO: Jack, understanding there's a threat but that 2021 could be a year of rebuilding in all kinds of sectors, not only in the United States but the global economy, how would the average investor position for that?
JACK ABLIN: Sure, so, you know, our our view is that we want to invest in a lot of the names that haven't participated in the rally. The fact is that, you know, large-cap growth has really been a safe haven play in many respects because of their balance sheet, their pretty predictable earnings growth pattern, and the fact that their businesses have been largely insulated from the vagaries of COVID.
But now that, perhaps, things are starting to free up, life ultimately getting back to normal in the second half of next year, you know, other names should be able to participate. You know, it's remarkable to me, Adam, that, for example, since March, Royal Caribbean cruise line's stock has outperformed Amazon stock. So I do think that-- and there's still a lot more room to run for what we're calling value but also quality value. We want to make sure balance sheets are solid enough and pricing power is strong enough to sustain themselves, you know, into the next several quarters.
SEANA SMITH: Seth, what do you make of this disconnect that we've seen? We've seen enough for quite some time, and it doesn't really seem to bother many people on the street. But the total disconnect between what's happening in the economy and what's happening in the stock markets-- right now, we're not sitting too far from all-time highs, yet the trend that we're seeing in COVID is so worrisome, and we're seeing that fallout, like we were just talking about, in the labor market. How are you kind of looking at this disconnect and, I guess, bringing it back to your expectations then for this quarter and then going head into 2021?
SETH CARPENTER: Yeah, I think a big part of the disconnect comes from the fact that this recession was a very, very, very unequally distributed recession. So we know that middle- and lower-income folks disproportionately were the ones who lost their jobs. The companies that ended up having the hardest time and closing were disproportionately the smaller ones, the ones that were directly relying on bank finance.
But, if you look at the corporate bond market, spreads have tightened a lot, partly due to Fed action. And there've been lots of issuance of corporate debt. So the bigger, better capitalized companies are able to take advantage of basically free money. And I think that bifurcation in the-- in the economy explains a little bit of it because the S&P, you know, the equity market reflects the largest part of the economy.
And then you add, on top of that, the monetary policy response, the Fed slashing interest rates on track to keep the federal funds rate at 0 basically for as long as the eye can see, a 10-year yield well below, you know, below 1%, I think all of that sets up for really high valuations for the ones who are doing well. And the ones who are doing well are disproportionately in the equity indexes.
ADAM SHAPIRO: Well, that brings--
JACK ABLIN: Could I add to that?
ADAM SHAPIRO: Go for it, Jack, because I have a question--
JACK ABLIN: Yeah, and Seth brings up a great point. And that is a lot of the moves that we see, particularly among high-quality companies, has really been fueled by monetary policy. And that's been great. You know, if you look at the total return of the S&P 500, for example, over the last 10 years, it's 260%.
One of the things I found remarkable was that 160 percentage points of that gain was valuation expansion. And that was largely due to just Fed largesse. The fact is that, you know, interest rates at all-time lows, Fed balance sheets at all-time highs. And the question now, you know, Adam, is, where do we go from here? Can we sustain this continued valuation expansion in a world where, perhaps, you know, Fed ammunition, monetary policy ammunition is now running dry.
And so one of the arguments for value is, if you look at earnings as of a function of price, right, PE. You just look-- you know, take the reciprocal, you're going to get a better deal, especially if we're relying on a world where we now have to, you know, look more closely at earnings, rely on earnings and dividends, rather than valuation expansion, going forward. So another argument, I believe, for quality value in this sector that just has really trailed the markets for the last dozen years or so.
ADAM SHAPIRO: Jack, I'm going to take this to Seth on something you just said because I think a lot of people feel that the only place they're going to get any kind of return, any kind of yield is going to be in equities. And yet, coming into 2020, we were actually anticipating a slowdown, a potential recession. And that's been put off by the quantitative easing and the monetary policy you talk about.
But, Seth, you don't see any end to that. So why wouldn't equities continue this trajectory higher, even if it's forming a bubble? Why not?
SETH CARPENTER: Yeah, I mean, so I'm not going to make an exclusive to equities call. But I think there's a lot to that story. I mean, one of my clients, I love the way he phrased it. We went from late cycle to early cycle in a matter of two months. And the last expansion went on for a record long 10 years. And, if we're at the beginning of a similarly long expansion but starting that off with the 10-year below 1%, I mean, I think there's a lot of argument there for what is driving these prices.
SEANA SMITH: Hey, Jack, when you take a look at what's already priced into the market when it comes to a vaccine, we saw the massive rally after we got the Pfizer news. And then, after we got Moderna, we didn't see quite the extend the rally that we saw with Pfizer, but still significant gains. Once we get this emergency-use authorization, if we do get it, what do you expect the market's reaction to be?
JACK ABLIN: Yeah, I mean, it's remarkable to me how we're taking all bits of news, even if it's the same good news all over again, and pretending like we haven't heard it before, and we're rallying on it again, which, you know, that's, I suppose, as an equity holder, that's fine. At some point, we will need to reconcile the economic underpinnings. So it's going to be, you know, call it two quarters plus another few months, where we are going to have to rely on the underlying economy to kind of come along with our expectations.
And, where COVID it is right now, it just is-- it looks like a pretty dire situation in the near-term. And we'll see if, you know, policy, whether fiscal or monetary, can paper over those differences.
ADAM SHAPIRO: Jack, when you talk about the expensive market and having a difficult time expanding in excess of earnings and dividends, what happens to-- a lot of people are really just passive investors through their 401(k) programs. What's going to happen to those people? Because, usually over a 10-year horizon, they do OK. But this time around, what?
JACK ABLIN: Well, you know, one of the things-- before I even answer that, I want to tell you I was probably one of the biggest proponents of passive investing all along. I latched onto exchange-traded funds in 1997 when the SPY first came out and had been, you know, one of the largest investors in ETFs all along.
But I will say, the beginning of this year really changed my view because of the winners and losers and what's going on underneath the surface. It does require individual security selection. And one of the things I point out is just take the Russell 2000, for example. Forget COVID. Forget pandemic and the lockdowns.
Even going into 2019, you know, a good 30% of the Russell 2000 has not made a profit in five years consistently. So there are a lot of zombies out there. There are companies that should have been out of business a long time ago that are still hanging around thanks to the easy financing and refinancing and so forth.
And so, for those investors who are buying into the total market, you know, ultimately, they'll probably be fine because the winners will cover up over the losers. But I do believe that individual security selection will likely pay off over the next few-- certainly for the next few years.
SEANA SMITH: Hey, Seth, real quick, when you-- kind of going off of what Jack was saying. But, when you take a look at how the pandemic has accelerated certain trends-- and we've seen a number of companies file for bankruptcy. But I also think there's going to be lasting economic effects from this pandemic. What lasting impacts do you see COVID having on the economy, going forward?
SETH CARPENTER: Yeah, I think that the place I look for the longest lasting adverse effect is in the labor market. So, if we think back to the financial crisis, we had labor force participation. And it doesn't matter if you sort of adjust for demographic shifts or not. This is the same story.
From 2008 to 2015, labor force participation just fell for those years. And it took until basically the beginning of this year-- so a 10-year, longest expansion on record-- before we were able to recoup the losses that that recession caused. We've seen a much sharper, direct fall in labor force participation.
And, as more people become permanently unemployed, there's a real risk of that gets worse. And so that just means people give up on the labor market. It means that the overall productive capacity of the United States economy is impaired and people are not participating. So I think that really is the kind of scar-- whether it's permanent or not, I mean, once you get beyond 5 to 10 years, the difference between permanent and temporary starts to blur.
ADAM SHAPIRO: Seth Carpenter is UBS Chief US economist. And Jack Ablin is Cresset Capital Chief Investment Officer. And, might I say, you've got the coolest piece of artwork we've seen in a long time behind you. Room Rater would definitely give you a 10. Even the Russian judge would give you a 10.