May 2021 Newsletter

It is time to consider a revaluation period for stocks.  During such phases market volatility increases. Value stocks tend to outperform growth stocks.  Price-to-earnings multiples become the focus.  However, with the money supply in the United States rising almost 30% since the beginning of the pandemic in 2020, it is unlikely stocks will enter a recession.  Rather, the fear now turns to inflation.  Jeremy Siegel, Professor of Finance at the Wharton School of Business, believes inflation could reach 20% over the next two to three years.  If so, stocks and real estate will likely go up with inflation.  The savings rate in the United States has reached fifteen percent.  Strategic cash is valuable to choose an investment entry point. Otherwise, cash is trash.  It is being skimmed by the government.  The government creates inflation.  The government increases taxes.  The government creates a climate for the decline in the value of the dollar.  The sum of fiscal and monetary stimulus recently put into the economy is unprecedented. 

Meanwhile, stocks continue to rise despite stretched valuations.  When stocks trade 20-30% above their 200-day moving average short term, investors tend to think about taking profits.  Longer-term investors can be more sanguine since trading in and out of the market too much can increase the probability of underperformance by selling when correction happens and buying back into the market after a rebound.  You just know there are millions of people who never got back into this market as post-pandemic risk clouded their minds.  So, what do you do now?  If you know someone who finds themselves in this dilemma, consider the following.  There have been seven selloffs in the market since June of last year.  Of course, past performance is no guarantee of future results, but consider what can be learned from these pullbacks.  I’ve listed the month, the percent decline and the number of days it took to witness a rebound.

  1. June 2020: 8.25% pullback-lasted 8 days
  2. September 2020: 10.86% pullback-lasted 22 days
  3. October 2020: 8.88% pullback-lasted 18 days
  4. January 2021: 4.56% pullback-lasted 7 days
  5. February & March 2021: 5.65%-lasted 19 days
  6. March 2021: 3.81% pullback-lasted 8 days
  7. May thus far: pullback-4.73%-lasted ? days

So, let’s build a case for skeptics.

  1. Past performance is of no value.
  2. As I have mentioned, we’re entering a phase of greater volatility.
  3. While corporate earnings are rising, the price-to-earnings ratios of stocks go down when the cost of capital goes up.
  4. If the business owner(s) can find labor, the cost is going to rise.
  5. Biden’s tax plan.  

OK, let’s assume we’re overdue for a 10-15% correction.  Perhaps this will happen sometime between June and October of this year.  If not, there are still more concerns:

  1. Two adages are in conflict, causing more volatility.  They are, “Sell in May and go away,” and, “Never short a dull market.”  They may both win leaving the returns for investors muted.
  2. The high end of the trading range is being tested for 2021.  Once it becomes clear to investors it’s time to test the low end of the 2021 trading range, selling will become more pronounced.
  3. The Cyclical Trend index, a metric that accounts for the number of weeks since the previous cycle bottom, is now flashing a negative signal again. A negative five signal is expected to show up the week ending May 28.
  4. The Sentiment Index, which tracks the excessive bullish or bearish conditions now sports a reading of negative four.
  5. Money flows into Short ETFs (exchange-traded funds) are improving.  
  6. An Iranian deal with the Biden administration may put pressure on energy stocks as new supplies could cause the price of oil to decline.
  7. The Federal Reserve Board (FRB) meeting in Jackson Hole, Wyoming this August will have an earful of inflation talk.  Expect news of tapering. That is, the FRB may announce plans to stop buying treasury bonds.  When they buy bonds, interest rates remain low. When they sell bonds, the cost of money goes up.
  8. Consumers are paying more for products.  For now, consumers have the money and are willing to pay.  However, if companies learn that profits cannot be maintained without lowering prices, a selloff in the market could ensue.  This is what the Fed is predicting.  For this reason, owning companies with pricing power is key to lower volatility and greater upside pricing.  Example: housing starts dropped significantly last month as many would-be buyers were being priced out of the market.
  9. If prices in the housing market begin to drop, consumer confidence will dry up and concern over stagflation may abound. This will cause the stock market to tumble.  
  10. In the United States, those who received stimulus money have driven the burst in consumer spending.  When fiscal stimulus money stops, many of these people will struggle.  Renters who engaged in rent deferral plans may find themselves exposed to the harsh reality that landlords are not open to accepting people with poor credit scores.    

So now, as the revaluation correction begins to unfold, you may ask how long it will take for a correction to unfold, from peak to trough and back to peak?  Barring a great black-swan event or recession, assume three or four months.  Since World War II, S&P 500 corrections have lasted an average of four months.

Remember, this revaluation correction scenario is occurring during a massive growth cycle.  Gross Domestic Product (GDP) is expected to rise some 6-8% in 2021.  Total earnings for the S&P 500 may hit $215 per share for 2021.  In April of 2021, the trailing price-to-earnings ratio on the S&P 500 was 27.60.  That is high historically.  However, by imputing a sharply discounted price-to-earnings multiple of 18.5 on earnings of $215 you get a valuation of 3977 on the S&P 500. As of this writing the S&P 500 trades at 4115.  Several analysts estimate the year-end value of the S&P 500 will reach 4400.  As many analysts from Warren Buffett to Abby Joseph Cohen have said repeatedly, when interest rates go decline, price-to-earnings multiples rise.  Conversely, when interest rates rise, price-to-earnings multiples should decline. So even a decline in market multiples from 27 to 18.5 times earnings should not frighten off longer-term investors. With all the cash floating around this post-pandemic nation, a 20 multiple could support a fair value of 4300 for the S&P 500.

Price-to-earnings multiples have historically remained in a range.  Spikes occur during periods of recession and inflation.  The chart below explores price-to-earnings ratios over a very long time.

The key to appreciating this chart is the recognition that investors must think counter-intuitively.  When price-to-earnings ratios are highest, it’s historically been a great time to invest.  This is because with growing earnings in a previously depressed market, a spike occurs when investors are convinced a recovery is underway.  To illustrate this point, note that the price-to-earnings multiple on the S&P 500 hit 123.73 in May of 2009.  The stock market bottomed out about the same time.  Investors were convinced price-to-earnings multiples would decline because earnings would be increasing.  Alternately, periods of very low price-to-earnings ratios represent periods of high inflation. Note the lowest price-to-earnings ratio on the chart was the December of 1917.  Think massive inflation to pay for the war.

Choice or no choice?  Really, all investors have no choice but to manage their assets in the time they find themselves.  Just the math please.  As such, I’ve broken this advancing economic cycle into four phases.

Four phases of stock valuations:

  • Phase 1: When both earnings and price-earnings-multiples are rising, stock selection is easy.  This phase encapsulates the first twelve months after recession lows.  Subtle differences in management style can make a big difference in total return.
  • Phase 2:  In this phase stock valuations are stretched.  Corporate earnings are rising fast, offsetting declines in multiples.  
  • Phase 3: In this phase price-to-earnings multiples are rising while earnings are decelerating.  This is a post-correction scenario and marks the beginning of a period where growth stocks are superior performers over value stocks.  We may be years away from this phase.
  • Phase 4: This phase is marked by a period of declining earnings and declining multiples.  Stagflation occurs here as interest rates rise while earnings remain stuck or go lower due to rising costs of labor and capital.

In summary, stay invested.  Expect pullbacks. Our current portfolio emphasis is on value-based and cyclical stocks.  They have done well in this Phase 2-like period of revaluation.  As the Federal Reserve Board (FRB) wants to create inflation, it’s wise to remain in equities.  The Fed is letting loose with trillions of dollars.  It could produce sky-high inflation for a short period of time.  If you know someone who has a 3-5-year investment time horizon and they’re in a quandary as to what to do, have them read this letter.  And of course, as always, thank you for your continued faith and trust in all we do here in La Jolla for you.  


Vaughn Woods, CFP, MBA

Vaughn Woods Financial Group, Inc.

2226 Avenida De La Playa

La Jolla, CA 92037


Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal.  Past performance is not a guarantee of future results.  Asset allocation cannot assure a profit nor protect against loss.  Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed.  Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management.  The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.  VW1/VWA261

Sources: The Leuthold Group,, Credit Suisse,, The Wall Street Journal, CNBC,,,