High Level Commentary


Ci Perf Hi Level 210618

Short-Term Positive:

-The $1.9 trillion government stimulus package passed in March is causing significant upward revisions to economic growth forecasts.  For example, the Federal Reserve revised their 2021 economic growth forecast on June 16th to 7.0%, up significantly from their 4.2% December forecast.  If this growth rate holds, it would be the highest economic growth rate since 1983.

-Some of the stimulus dollars are moving into the markets.  This provides short-term investment demand to push prices higher.

-COVID-19 vaccines are bringing an end to shutdowns.  There continues to be concern, however, regarding the pace at which states open up, and by the impact of virus variants.

-Pent-up savings, pandemic constrained spending and pent-up demand should increase near-term economic growth.

-2021 Q1 earnings are coming in well ahead of consensus expectations.  FactSet is showing 1st quarter earnings up 49%, compared to last year.  With these strong results, the 2021 full-year earnings are being revised significantly upward.

-Investment performance for 2020 was led by technology, but performance has broadened out in 2021.  The “Reflation Trade” favors energy, industrial and financial companies that are both cheaper and that offer more upside as the economy recovers.

-Some investors believe we are in the early stages of a new bull market and are describing the current market environment as the “Roaring 20s.”  This optimistic perspective is based on sustained upside to economic growth and corporate earnings.

Short-Term Negative:

-Consumer inflation is increasingly reflected in current data with the May Consumer Price Index up 5.0% year-over-year.  Federal Reserve officials say any inflation will be “transitory”, but history shows that inflation is hard to contain after it has gained momentum.  The market is very concerned that inflation may prove to be more than transitory.

-The Federal Reserve’s so-called “Dot Plot” forecast on June 16th showed the Fed raising short-term interest rates twice towards the end of 2023.  Previously they had communicated raising rates in 2024.  The market is also concerned about when the Fed will begin tapering their $120 billion monthly purchases of treasury and mortgage bonds.  

-Asset inflation (both stocks and bonds) has pushed market prices above average fundamental valuation levels.

-The Federal Reserve’s monetary stimulus has kept interest rates low but it distorts markets by shifting investors towards risky assets.

-Valuation levels are particularly expensive for U.S. stocks and long-maturity bonds.

-Speculative red flags include GameStop, Bitcoin, AMC, Tesla and the proliferation of SPACs.  This speculative demand is driven in part by increased retail demand and especially investors who are confusing gaming with investing.  Current speculative momentum could reverse quickly.

U.S. Economic Statistics Remain Positive but inflation concerns are increasing.  Economic statistics dropped precipitously due to the government-induced shutdown in 2020, but then rebounded well above consensus expectations.  Most recently, economic reports are showing accelerating growth. 

-US First Quarter 2021 GDP moved up 6.4% on an annualized basis.  This was a good report, with continuing gains for consumer spending. 

-Unemployment (at a 50-year low of 3.5% in February 2020) spiked to 14.7% as the pandemic shut down the U.S. economy, but has since dropped to 5.8% for May.  Job creation for May came in at a mildly disappointing 559,000.  The weak jobs number caused investors to believe that easy monetary policies will stay in place for longer.  The weak jobs number also provided support for President Biden’s economic stimulus plan.  Meanwhile, initial claims for unemployment insurance, a proxy for layoffs, dropped below 400,000 in May after staying at a stubbornly high range of between 700,000 and nearly 900,000 since the pandemic began.

-Retail sales plunged as the pandemic shut down U.S. consumers with a-14.7% decline in April 2020, the largest decline since 1992 when this data series was initiated. However, retail sales have rebounded significantly due to gradual reductions of lockdowns and government stimulus checks.  Retail sales were down -1.3% in May 2021 but retail sales are now above the pre-pandemic level.

-Industrial production advanced 0.8% in May and is now up 16.3% on a year-over-year basis.  A shortage of semi-conductor chips continues to constrain domestic car and light truck production.

-Housing has been strong due to low mortgage rates.  New construction is currently negatively impacted by rising mortgage rates and rising lumber costs.  Fortunately, lumber prices have come down recently.

-Inflation has been low, but is increasing.  The Consumer Price Index came in at trailing 12-month rate of 5.0% annualized rate in May, much higher than the 4.7% consensus expectation.

-The Leading Economic Indicators came in at a positive 1.3% in May, the thirteenth consecutive monthly gain.  When the pandemic first hit, the data was negative with March down -7.5% and April down -6.3%. These statistics showed a sudden, large shutdown of the U.S. economy caused by the unprecedented coronavirus pandemic.  Since that time, the U.S. economy has recovered much faster than expected.

-The European Union has revised upward their 2021 GDP forecast from 3.9% to 4.2%.  The EU is forecasting 2022 GDP at 4.4%.

-Japan’s 2021 Q1 GDP came in at a -1.3% quarter-over-quarter level due to widespread COVID-19 lockdowns that crimped consumer spending.  Japan is expected to recover in the second quarter, and the consensus expectation is for a 3% 2021 GDP increase compared to 2020. 

Performance:  U.S. stock indexes moved up to record-high levels based on government stimulus and optimism with COVID-19 vaccine and lower levels of hospitalizations and deaths in the U.S. and Europe.  The positive news related to the rollout of vaccines shows that the market is pricing in better prospects for the economy and corporate earnings.  Energy, industrials, financials and small cap stocks have outperformed recently as the market rotated away from some of the tech darlings (Apple, Facebook, Alphabet/Google).  Small cap stocks are cheaper and have more earnings upside as the economy recovers from the COVID-19 lockdowns. 

Although bonds were positive in 2020, longer maturity bonds have underperformed in 2021.  While fiscal stimulus is necessary as we face the COVID restrictions and lockdowns, there is a growing concern related to potential inflation and to huge government budget deficits.  Investors are less willing to accept historically low longer-term government debt, and this is pressuring long-maturity bond prices lower as yields move higher.

GameStop, Bitcoin and Dogecoin have been big performers.  Retail investors have added volatility to speculative stocks in 2021.  They first targeted Gamestock.  They initially drove the stock up as they purchased the stock and call options on the stock, forcing hedge funds with short positions to cover their short positions.  Investors with short stock positions essentially borrow stock and then buy it later to close out their positions.  Investors take short positions when they expect the stock to decline.  GameStop has been a favorite stock to short because it is a bricks-and-mortar video game store with declining revenue and profits.  Short positions on stocks can be lucrative if stocks decline sharply, but are very risky when stocks rise.  Retail investors used Reddit’s WallStreetBets, web site to coordinate stock and call option purchases as they encouraged one another to upset the Wall Street status quo.  This was described as a David and Goliath story.  Although many retail investors achieved huge short-term gains and have forced huge losses on the hedge funds with short positions, there is little fundamental reason to hold these stocks on a long-term basis.

COVID19 and Positive Gains for Vaccines and Treatments:  The Pfizer/BioNTech, Moderna and Johnson & Johnson vaccines are being rolled out in the U.S., and Astra Zeneca/Oxford is being utilized in the U.K and in Europe.  At this point, they are showing high efficacy rates at over 90%.    The J&J vaccine is noteworthy because it requires only 1 shot compared to the others that require an initial shot and then a follow-up shot.  These are very encouraging results, and vaccine production is expected to increase significantly throughout 2021.  A key question remains regarding how well these vaccines work for the variant mutations first seen in the U.K. South Africa and Brazil.  Another question relates to how long the vaccines provide immunity before a booster shot might be needed.

Vaccines and treatments hold the promise of allowing the global economy to get back closer to normal.  Dr. Anthony Faucci continues to express optimism regarding vaccine and treatment approvals.  Unfortunately, India and Brazil continue to struggle, and completing vaccinations on a global basis will not be achieved until 2023. 

Markets have also reacted positively to President Biden and the recently passed $1.9 trillion stimulus bill.  The market is also taking a positive view of the President’s proposed infrastructure plan.  This plan involves raising taxes on high-income households over $400,000 and increasing the corporate tax rate from 21% to 28%.  The tax increases are described as raising $2 Trillion over a decade.  There is no Republican support for the plan, but a compromise may be achieved for a smaller package.

Two-Track Economy.  Although the U.S. economy is recovering, employment and overall economic activity remain well below pre-pandemic levels.  While manufacturing has rebounded significantly, service sector growth is less robust.  Lower-income workers have been disproportionately impacted by service sector job losses, and this leads the characterization of a two-track economy.  This economy is also described as being “K-Shaped”, with some groups doing quite well and others trending downward.  There is a clear need for a targeted fiscal stimulus package and hopefully a compromise package can be structured now that we are past the election.

Market valuations remain rich.  At this point, markets are trading on accelerating 2021 earnings.  Various valuation metrics (like Price/Earnings ratios) for 2021 are still elevated.  It is important to remember that valuation doesn’t predict short-term performance, but valuation definitely impacts long-term performance potential.  In other words, markets could continue to get move up on a short-term basis, but the longer-term performance might be a 5-7% average long-term return/year rather than the historic 10%/year return.

Stimulus packages helping in the short run, but debt keeps growing.  Three stimulus bills have been enacted since the beginning of the pandemic in March 2020. 

-The $2.2 trillion CARES Act, passed quickly in March 2020, provided $1,200 direct payments and enhanced unemployment benefits.  

-The $900 billion Pandemic Relief Bill passed in December 2020.  This provided $600 in direct payments to eligible individuals and $300/week in extended unemployment benefits through March 2021.

-The $1.9 trillion American Rescue Plan passed in March 2021.  This plan included $1,400 direct payments to most Americans and extended additional unemployment benefits through the summer. 

The Biden administration is proposing a $2.3 trillion American Jobs Plan for infrastructure and other spending, and also a $1.8 trillion American Families Plan.

The U.S. federal debt stands at $28 trillion, and is expected to continue to grow for the foreseeable future.  Although current interest rates remain low, future inflation could cause rates to rise, and this would cause sharply higher debt service costs.  This is clearly a headwind on a longer-term basis.

For more detail see:

Markets & Economics

Market Performance


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Yahoo Finance link is helpful for daily market activity:  http://finance.yahoo.com/