If you’re scouring Wall Street research and opinions for a reason why the current stock market isn’t stretched, you don’t need to look beyond the “pent up demand” explanation.
You see, to this way of thinking, the coronavirus pandemic and the various slowdowns and shutdowns of economic activity have led people to put off purchases. And once the coronavirus vaccines have put the virus and virus fears to rest, consumers will come rushing back into the market place to make all those delayed purchases.
So stocks should be valued not on current revenue and earning but on their prospective revenue and earnings once we reach a world that releases all that pent up demand.
Before you pay up for stocks based on that scenario, it’s worth a few minutes to exam why “pent up demand” might be fundamentally wrong. Or at least in need to some nuance.
I can see the argument for pend up demand in consumer purchases of things like cars or even vacations. People have put off purchases like these because they did’t feel safe making the purchase or going on the trip. And when coronavirus fears are behind us, people will return to car showrooms and airplane ticket counters. But I do have to question how much that pent up demand will be reduced by the beating that many families have taken during the pandemic. The data right now shows families dipping into their checking accounts to keep food on the table, to pay rent, to keep up with medical insurance and necessary medical care. Families aren’t going to come out of the pandemic with a lot of spare cash for completing those postponed purchases. Some buys that were postponed will stay postponed.
I don’t think we should ignore trends that show an increase in spending during the pandemic by families that could afford it. Home projects, for example, showed an increase in spending during the pandemic as families who were stuck at home decided to upgrade a kitchen or add more counter space or those home cooked meals. Stocks like Home Depot (HD) and Lowe’s (LOW) up 25.46% and 38.26%, respectively, for 2020 through December 15, have already received their “pent up demand bonus.”
We also shouldn’t ignore shifts in spending behavior caused by the pandemic and that will outlast the pandemic. For example, The data suggest, and that’s all it is “a suggestion” at the moment, that companies that have discovered they can live without business trip during the pandemic will continue booking business travel at reduced frequencies. Which would be a big deal for airline profits even if vacation travel bounces back. Business class accounts for just 12% of revenue for airlines but 75% of profits.
And last, investors should recognize that some of the goods that weren’t purchased during the pandemic won’t be purchased in any recovery. For example, fast food meals. Cheeseburgers that were foregone in July 2020 won’t be consumed in July 2021. Yes, revenue will bounce back as people resume eating at McDonald’s (MCD), ordering Coke’s at fast food joints, ball parks, and (maybe) even movie theaters. But there isn’t some extra demand for those goods that will dematerialize once the pandemic is over.
Next and final (maybe) part of my series on Signs of a Market Top, I’ll try to construct a valuation or two in a stock market that doesn’t care about valuation.
