People around the globe are being vaccinated, and there is a light at the end of the tunnel, driving stock investors' enthusiasm. With Congress passing a $1.9 trillion coronavirus relief bill, consumers will have more spending power.
We all saw what government stimulus did to equity markets in 2009 and now 2020, so there is reason to be hopeful. Unfortunately, the government and central bank's help can't get workers back to work during a pandemic. Of the over 20 million jobs lost since the pandemic, only roughly half have been recovered. The good news is this could change soon as many parts of the country ease social distancing restrictions.
Further adding to optimism, households in the upper tax brackets have been saving money, and those in the lower brackets are also about to have more to spend. But stock markets are forward-looking, and already trading at all-time highs; how much of this optimism is already included in these stocks' price?
In past outlooks, we have written a lot about high valuations, which remain today. Stocks are trading at high prices relative to their earnings, suggesting much of this relief package and reopening is reflected in stock prices. This recovery is virus-dependent, creating unique risks like virus variants wreaking more havoc on mankind and economies. Additionally, bond investors are aware that consumers are about to spend a lot more money as restrictions ease. These investors have been demanding higher bond yields, sending bond prices lower and jitters through stock markets as higher borrowing costs are not good for corporations. They fear the risk of higher inflation.
We have already seen manufacturing input costs rise, making sense to see inflation pick up soon. However, we think the rise in inflation will be somewhat short-lived and will pass. It is a big risk, and we will be watching for signs of persistent inflation carefully. This fear of inflation may continue to be a headwind for longer-maturity Treasury bonds. Corporate bonds of both investment grade and below investment grade varieties are offering relatively low amounts of yields or compensation over their safer government counterparts, as investors are expecting few rating agency downgrades and corporate defaults. This makes them more sensitive to stock fluctuations.
Despite a lot of uncertainty around business reopenings, vaccination rates, and economic growth, equities delivered a solid performance last quarter. Looking back, while it's easy to focus on the quarter's overall performance, let's not forget that there were many dips and rallies along the way.
Bottom line, we can expect more volatility and uncertainty this year. After nearing record highs, it would not be surprising to see a marked drop in the second quarter.
What lies ahead? A popular survey of economists suggests that the economy could grow ~7% this quarter as the economy continues to pick up steam.1 However, many variables and uncertainties baked into those projections: vaccination timelines, consumer spending, new government regulations, and business expectations.
Overall, we are cautiously optimistic about where the economy and markets will go this quarter. However, we're keeping a close eye on market conditions, as continued uncertainty could drive sudden changes.
Questions? Please reach out to us at 207-761-4733 or email@example.com.
1 https://www.wsj.com/graphics/econsurvey (March 2021) Archive link