Market Action in February:
- Despite plenty of fireworks in a handful of somewhat wonky assets, major asset classes were up slightly in February, with small caps leading the party. The first week of February saw the S&P 500 Index jump back to all-time highs, while markets, especially technology, traded off towards then end of the month on inflation fears.
- 10Yr Treasury yields are marching higher and closed around the 1.50% level, in-line with the S&P 500 dividend level – a pivotal ST level. For reference, at the end of January, the 10Yr Treasury was ~25bps lower than the S&P 500 dividend. We are likely nearing the point where mortgage rates will start nudging higher. 5YR Breakevens (market estimated inflation over the next five years) is 2.25%, above the Fed’s desired 2% threshold – remember, Powell said he’s let this run hot for a bit, i.e., above 2%. Ultimately, the yield curve is pricing in higher inflation expectations.
- The Fed promised that rates would remain in the 0% – 0.25% range through 2023, with the goal of stoking inflation to moderately exceed 2% for some time. Though, with the capitulation in the bond market, yields are now pricing in an increase towards the end of 2022. The Fed Minutes in December mentioned a plan of a gradual tapering of purchases similar to 2013/2014. From May to August 2013, the 10YR UST yield jumped from 1.6% to 3.0%.
- In late December, Congress passed a $900B fiscal package for pandemic relief, which was roughly the size of the fiscal package passed in 2009. Most of the funds will be into the economy within the next six months. The package is centered around funds for vaccine distribution, unemployment insurance extended for 4 more months ($300/weekly Federal checks), $600 stimulus checks, and rental eviction moratoriums.
- Meanwhile, the next relief package is being debated, as it moved through the House last week, with the Dems plan at $1.9T and the GOP counter at $600B. It feels like the compromise arrives in March at or around another $1.5T, though even some revered Democrats are against a bill this size…cough, Larry Summers.
- COVID developments over the last month have been a mixed bag. Present-day COVID stats – new cases, hospitalizations, etc. – continue to improve. Conversely, variants from the UK, South Africa, etc. have brought newfound concerns. JNJ had success in their single-dose vaccine candidate, which received an emergency use authorization (EAU) over the weekend.
- Economic data is improving but the gains have softened from the initial V-shaped bounce. Optimism thrives on vaccine developments, but the winter could be a slog depending on outcome from virus stats, lockdowns, and stimulus.
- Non-farm payrolls only gained 49K jobs in January. Payroll gains have hit a wall and are essentially flat over the last three month (with the revisions). We are still at 10M jobs lost from COVID – above that lost during the GFC. It appears that for the economy to see more job creations, the economy and schools will have to open.
- Signs of a bubble – Bitcoin has more than doubled to $50,000 over the last month. Bitcoin’s low in March was under $4K. Tesla’s stock is up nearly 800% from its March lows and has almost doubled in price since November.
- Since the start of last year, investors have poured more than $130 billion into SPACs, “blank-check companies” traded on an exchange with the goal of merging with a private company to bring it public. The market has seen more companies publicly list their company at valuations over $1B and with zero revenues than what we saw in 2000.
- Earnings season for Q4 was excellent. Per Factset, 81% of companies have beat expectations. The blended growth rate is +1.7% vs. an expected decline of 9%. The market has not rewarded earnings surprises nor punished misses. Full year 2020 EPS decline is slated at -11% and a revenue decline of -1%. 2021 EPS forecast at +23% and revenue growth of +9%.
- Last year S&P 500 operating earnings = $165. Bottoms-up for 2020 = $135 (was as low as $125 in June). 2021 = $173.
- S&P 500 fwd. P/E is at 22x. CAPE Ratio is 35x. EAFE is 18x forward P/E, while EM is at 16x. R1V is 18x v. R1G at 31x.
Market Stories for March
- Thanks to vaccine developments, there is now light at the end of the tunnel, and markets are pricing in a strong recovery in 2021 propelled by low interest rates. Still, the best fiscal stimulus the economy can have is reopening the economy.
- This is not a normal economic cycle, which are cause by financial excesses. This may help explain the stealth recovery in asset prices (along with the Fed flooding the markets with liquidity).
- We would expect bond yields to reflate as the pandemic improves and economic activity begins to normalize. That was certainly the case over the last month, as the 10Yr now trades above its pre-pandemic level.
- Should a successful vaccine allow for the resumption of normal economic activity, our expectation is that rates will rise, and market leadership will shift away from Tech Growth into more downtrodden components of the market and the last week of February showed this.
- Longer-term, valuations and bond yields will eventually matter, and both will lower expected returns for balanced portfolios.
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