May 15, 2021
As we “celebrate” the first anniversary of the “just two-week lockdown” to bend the curve, the economy remains a mess even though Wall Street is doing fine. Another $1.9 trillion will be doled out over the coming weeks and months to help the economy and those impacted by job loss recover. Until the economy opens fully, it will be hard to restore jobs, especially in the service sector. Market psychology has shifted from benefiting companies helped by working/staying at home to a hopeful reopening of the economy. The bond market is sniffing inflationary pressures and concerns about the time when the population is unleashed from a restricted lifestyle. Interest rates have increased significantly and this week we will hear from Fed Chair Powell regarding their position on keeping rates low for longer and when it will begin to shift. As the weather warms and vaccines find arms, the summer is expected to be “more normal”. Anything less will be a huge disappointment after the past year.
The economic damage of the past year is still very evident in the weekly jobless claims figures. The average of the past year is roughly 50% higher than the average during the financial crisis. The response from the government has been multiples more than during 2008-’09. Unlike that period, this one is completely health related and will take broader vaccination and local governments to relax restrictions on the service economy to realize a stronger recovery. The inflationary worries have not yet shown up in the “official” data, as both consumer and producer prices were as expected and are still well below the Fed’s 2% target. That will change in the coming months as commodity prices have jumped by over 20% since the end of last March. Even pulling out the usually volatile food and energy, prices are expected to soon be above that 2% level. If consumers have money to pay the higher prices, inflation can linger. The extension of various programs into fall may allow many to have money in their pockets and keep the pressure on prices. Once the economy fully recovers, wage growth will be the key driver for “durable” inflation. This dynamic will be under the microscope at the Fed meeting and the press conference that will follow. The markets are sure to react.
The bond market has been at the center of investor’s focus as longer-term bond yields have been rising in response to expectations for higher economic growth and inflation. The impact has been felt more in the treasury market and to a lesser extent the corporate bond. Corporate bond (and to a lesser extent) municipal bonds are dependent upon the health of the specific issuer. Better economic growth and higher local tax revenue will benefit these parts of the bond market. The huge issuance of treasury bonds to pay for the various pandemic programs will have a tougher time to be absorbed within the market, pushing rates up on government bonds.
After being neglected for the better part of 10 years, other parts of the markets are indeed waking up. Small stocks are up better than 20% just this year. Energy, the black gold variety, is up over 40%. While much of the attention has gone toward technology, this shift toward “everything else” has been picking up steam over the past six months. Some of this is due to expectations for better economic growth. Energy has been pushed down so far that it was impossible to find storage a year ago and you could get paid to hold it (assuming you had a few tankers in the backyard!). Today, pump prices are at or over $3/gal. Smaller stocks tend to be more domestic and do not have as much international exposure as their larger cousins. Many of these companies suffered in the early days of the pandemic and for those surviving, they are likely to thrive as growth picks up.
Interest rates and investor ebullience may be the only things to derail the markets over the long-term. Over the short-term, stocks may take a rest especially in front of the Fed meeting this week. Volatility has not subsided, but few notice it when stocks rise!
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions