Market Review - Q1 2021
Such is the nature of the news flow in today’s society that it might be hard to remember that a little more than three months ago, President Trump passed the last COVID relief bill, clocking in at around $900 billion. That was before a quarter that was to see:
The inauguration of President Biden,
A blowout earnings season,
The emergence & drama of meme stocks like Gamestop & AMC,
Incipient fears of higher interest rates and inflation,
Yet another COVID-relief bill to the tune $1.9 trillion or a little less than 9% of GDP, and
Global M&A activity reached its highest level since 1980 and 10-year Treasury yields doubled in the quarter.
Driving optimism in Q1 was the accelerating pace of vaccinations in the US. We have exceeded goals set in February with the current rate of 4 million vaccinations a day. The vaccine distribution has been quite smooth overall, despite the partisan divide in the US. This led to a definite shift in stocks leading the way in the first quarter that benefitted from the idea of an opening economy (as opposed to the “Work-from-home” stocks that excelled in 2020. As such, the 10-year Treasury yield surged and the US dollar increased with the prospects of better US growth playing out.
Additionally, a new Democratic government delivered on its promise to further stimulate the US economy with a $1.9 trillion front-loaded spending package. The US will now have more fiscal stimulus in 2021 compared to 2020. In Q1, Treasury distributed an astonishing $643B to US consumers (11.7% of GDP annualized), up from $196B in Q1 2020. This larger stimulus spending comes with unemployment falling and the US economy re-opening unlike last year when jobs were hemorrhaging, and the economy was shutting down.
Taken together, the US economy may experience its fastest growth rate since 1983. The key question for investors is: what’s next? With the economic recovery taking hold and COVID waning, President Biden is transitioning to his next agenda item: $4 trillion of new infrastructure spending coupled with $3 trillion of tax increases. This proposal shows that many of the tax increases are immediate, but the spending takes years. The months ahead may show some of the best economic months of our lifetimes, but the massive stimulus associated with COVID will begin to fade with the virus and investors at some point will begin to focus on the tax increases (fiscal tightening).
The Backdrop for 2021:
The Good -
Faster-Than-Expected Vaccine Rollout – Return to “Normalcy” is the gamechanger - the best stimulus is an open economy. Furthermore, the Fed said that once the U.S. achieves 75% immunization, that they would consider beginning the tapering discussion. If we look at the current pace of vaccine distribution, we could see the U.S. hit this threshold number by mid-June.
Better Economic Data - Economic data, which lags the stock market, hit rock-bottom last year, but we believe signs of a recovery have continued to appear, most notably with the recent Non-Farm Payroll and ISM data. Now that we have a fifth round of stimulus from Congress, especially within the unemployment area, and the potential for an infrastructure bill, we believe that we will continue to see increased consumer spending and job stabilization – both keys to getting out of this pandemic-induced recession.
Better than Anticipated Earnings – Given the record amount of stimulus, and that S&P 500 earnings are only 13% below its peak, we believe earnings growth will continue to be a determining factor of success for corporate America, pending tax changes. Moving forward, we believe that if earnings growth in 2021 can surpass the multiple contraction that we could potentially see, since we are at 99th percentile multiple, positive future performance could occur.
Health of the Consumer – We believe the aggregate consumer is flush with cash, and once pent-up demand can safely be unleashed, the U.S. economy is set to rip higher. While we know that the cruel nature of the pandemic has had an adverse financial impact on many (particularly those less fortunate), in aggregate, the consumer coffers are presently funded. U.S. bank deposits are up more that $3 trillion from a year ago, while credit card balances are down 12% over the past year.
The Bad -
Variants Causing Another Shutdown - After a significant decline in COVID-19 cases in the U.S. earlier this year, variants of concern (VoCs) continue be a risk, as there have been strains, i.e., “P.1 Variant”, that are more contagious than the original strain.
The Ugly -
Possible Policy Errors Through Fiscal Tightening (Taxes) in 2022 - The lags associated with the long-term benefits of infrastructure spending are notoriously long and variable. Tax increases, on the other hand, tend to be retroactive and immediate. From a market perspective, the fear is that a fiscal drag sterilizes the positive impacts of reopening and already passed stimulus, leading to an economic environment more consistent with the period of secular stagnation after the GFC.
Faster-than-Expected Inflation – The magnitude of the policy actions used to counteract deflation may, in the end, be hugely inflationary. Higher-than-expected inflation tends to be a major headwind to equity valuations. Right now, 5YR inflation breakeven figures are above the Fed’s 2% target. For markets how the Fed chooses to address inflation is as important as the inflation itself.