The old adage, “what a difference a year makes”, may never again resonate more with the U.S. stock market than this past 12 months. From shuttering businesses and entire industries halting, to explosive social-media-driven stock crazes and large double digit returns in the global markets, investors experienced a true roller coaster of sentiment and returns. With a variety of clashing forces affecting market performance already this year, the only certainty is the “ride” will continue.
Does saving equal spending?
Presently, U.S. economic growth is accelerating as vaccinations rise and social distancing measures ease, but hopes for a long-lasting spending boom likely will be littered with bottlenecks. The additional COVID-related fiscal stimulus measures implemented in early 2021 further bolstered consumer finances, creating a spike in the household personal savings rate. As mobility increases and the path to a fully-reopen economy becomes clearer, many believe the uptick in savings will be spent quickly. However, it is premature to assume a long-lasting spending boom will emerge. The U.S. labor market is still quite fragile, consumer spending habits may have become more prudent, and the math for a rebound in services is much different than goods. According to a survey by Bloomberg in February, most people plan to save the bulk of this most recent (third) stimulus, followed by spending it on food and housing. Also, pent-up demand in goods has arguably been satisfied with the manufacturing sector seeing an improvement in demand and sentiment. Although prices have surged and business are still experiencing supply chain issues, the manufacturing indexes for purchasing are in expansion territory.
Vaccinations globally are progressing at different speeds
Vaccine rollouts in major countries across the globe have varied greatly, and stock market data has contradicted what vaccination data would seem to imply for investors. It would make sense to think those countries with the most vaccinations would be outperforming the lagging countries, but, as is often the case, investing isn’t that simple. Market performance is literally the reverse of vaccine rollout. Countries like the UK and US lead the world in vaccine rollout with the EU and China lagging far behind, yet year-to-date China has been the best performing global market and the UK has been the worst. The vaccine-led recovery is arguably the most important factor for stock markets around the world, but investors should not get caught up in which country is winning the vaccine race. Global sales matter more than domestic. For example, UK stocks get only about 23% of their revenue domestically and are dependent on foreign trade for the rest. The path of vaccinations for the rest of the world is more important to the revenue of companies in the UK than its domestic vaccination progress. A widespread increase in vaccination production and availability will likely drive continued strong earnings and a global economic recovery, expected later this year.
Fixed Income: Real rates on the rise
Bond yields rose to the highest level in a year in early March, with the 10-year Treasury moving slightly above 1.6%. Most notably, real interest rates—bond yields adjusted for inflation—have been rising. After dropping to as low as -1.0% last year, 10-year real yields have moved up by about 35 basis points to -0.65%. While still in negative territory, that’s a big move in a short period of time. Rising real yields reflect optimism about the economic recovery, and markets are beginning to price in a return to more normal interest rate levels.
Aren’t rising interest rates bad for the economy?
An increase in interest rates tends to raise the cost of borrowing, which in theory discourages consumer spending and business investment in equipment, capacity and employment. This contraction in spending can slow growth in the economy, earnings and jobs. In practice, the relationship between business investment and interest rates is more ambiguous. Often, rising demand can accompany rising interest rates, compelling businesses to expand despite the higher costs. Recent data seems to be following this latter scenario, suggesting higher rates are having little to no negative impact on business plans at this time. While rates have climbed steadily, surveys of business optimism and investment continue to rise as well.
Hippity, Hoppity, the bunny is on its way
This probably is not the beginning of a bear market, but it feels less like a bull market compared with last year’s charge. The passage of the $1.9 trillion fiscal stimulus package and the pace of vaccinations picking up coupled with the jitters of rising interest rates, looming inflation, and worries over the potential withdrawal of central bank stimulus next year have led this to be more of a “bunny” market, with the stock market hopping up and down, which may provide some insight into stock market performance for the next 12 to 24 months.
Here are just a few of the current bull and bear themes, respectively:
Bulls Say:
- Market jitters over the consequences of an interest rate rise may be premature. Rates are still low on a historical basis, despite their sharp ascent from last summer’s all-time lows. Fed Chair Jerome Powell has been explicit that the Fed is likely to keep short-term interest rates near zero and will maintain a large balance sheet until the unemployment rate falls back toward pre-pandemic levels, even if that means inflation overshoots its 2% target.
- The Federal Reserve’s role in influencing rates has expanded, and there is still excess capacity in the economy. Congress continues to demonstrate its ability to intervene and provide needed assistance to both business and individuals, which helps buoy the global economy.
- Business sentiment and investment is booming, with robust M&A activity leading the charge. As of March 12, announced global merger and acquisition deals totaled $1.1 trillion for this quarter, putting the first quarter of 2021 on track to be one of the biggest, ever.
Bears Say:
- Should interest rates continue to make their way higher just as rapidly as they have over the past 6 months, climbing at an annualized pace of two percentage points, they could begin to weigh on growth.
- Many businesses and industries are still shuttered or running at reduced rates, the unemployment rate is still high, and schools are not fully re-opened, limiting the return to work for many parents and local educators – all of which hinders a quick rebound to “full” spending.
- At some point, someone will have to pay for the stimulus. The amount of fiscal and monetary stimulus has been record-breaking, and it has done a lot for propelling a global economic rebound, but at a cost. Policymakers in the UK, US and Europe have called out the year of the payback to be 2023. Economists agree that although we can move forward with reprieve until then, it will be difficult to avoid much past 2023, making it plausible to expect changes in fiscal policy in the somewhat near future, such as an increase in tax rates.
The reality is the market is reacting to a great deal of opposing economic themes. Positive data, government intervention and overall sentiment are driving the recovery, but it is prudent to remain diligent as the government life raft slowly floats away and changes loom for long-term monetary and fiscal policy.
Sources and Citations: “Stimulus Payback: 2023” by Jeffrey Kleintop, Charles Schwab Institutional, March 29, 2021;“Moving, With Bottlenecks” by Liz Ann Sonders, Charles Schwab Institutional, March 2021 (paraphrased); “Bull, Bear, How About A Bunny?” by Jeffrey Kleintop, Charles Schwab Institutional, March 15, 2021 (paraphrased)