Nonsense in the Right Market Environment
Way back in 1972, after seeing how enthralled Europeans were with any music associated with the United States, Italian singer Adriano Celentano decided to test their appreciation of anything American when he released "Prisencolinensinainciusol". The song's lyrics were intended to sound like American English to foreign ears, but were actually nonsense verse. The meaningless music became a top 10 hit on the pop charts of several countries in the Old Continent, proving that in the right market environment pure gibberish can be a smashing success. In fact, videos of live performances of the song on Italian television, which include throngs of choreographed background dancers, have become a bit of an internet meme over the last decade.
Headlines and Memes
Just looking at the news headlines, an internet meme celebrating nonsense could seem fitting for the financial markets in 2021. Stocks shoot up in value and then quickly plummet in price, not due to changes in a company's projected cash flows but due to chatter on message boards. New software companies, cryptocurrencies, and even parodies of cryptocurrencies rise in value thanks to celebrity tweets.
At times like this, financial security selection can devolve from a cleverness competition to a gambling game to ultimately a farcical frenzy. Concerns about irrationality often lead to worries that we may be in a market bubble. While bubbles are only easy to predict in hindsight, there are reasons why long-term investors can remain bullish about the current stock market.
First, corporate earnings are good and somewhat underappreciated. With over 80% of the companies in the S&P 500 having released their fourth-quarter 2020 (Q4 2020) financial reports, the largest US companies are beating analysts' earnings estimates by an average of 14.6% - the fourth-largest earnings surprise percentage since data provider FactSet began tracking the metric in 2008, and the companies are issuing positive guidance for the first quarter of 2021 at an above-average rate. The market has yet to reward this positive news as it has in the past.
Over the last five years, companies that have reported positive earnings-per-share (EPS) surprises have seen their stock price increase +0.9% on average two days before the earnings release through two days after the earning release. For this earnings season, companies with good news have actually seen their shares fall slightly (see the chart below).
Secondly, the latest economic data show strong consumer sentiment. January retail sales advanced 5.3% - well ahead of the consensus market estimate of 1.1% - with gains across the broad spectrum of retail stores. Surveys of managers in both the manufacturing and services sectors released last week indicated that positivity about the near economic future remains very high.
Finally, the federal government is positioned to bolster equity prices. Trillions in fiscal stimulus for pandemic relief and infrastructure spending have been proposed for this year. Federal Reserve Chairman Jerome Powell reiterated last week the central bank's plans to maintain an accommodative monetary policy until employment returns to normal levels. Under such an impecunious interest rate environment, equities will remain a strong option for income investors. So as Adriano Celentano's catchy tune shows, nonsense has always been with us, and it doesn't mean that everything is going to fall apart.
Quote of the Week
"I am not a cat."
An impromptu anthropomorphic update from stock trader Keith Gill during his opening remarks to Congress last week. Gill, who goes by the pseudonym "Roaring Kitty" on YouTube and whose Internet posts became closely associated with the surge in GameStop Corp. shares, testified before the U.S. House of Representatives' Committee on Financial Services about the upswing in volatility and trading disruptions brought about by the excitement over "meme stocks" in 2021.