Stock market outlook remains cautiously optimistic, with momentum on the market's side. Consumer net worth and corporate earnings are up, but the market feels stuck in a loop. Here's why:
Market Update/Overview: Cautiously Optimistic
- Momentum and optimism are on the market’s side
- M2 up 26% year-over-year
- Fed Balance Sheet up about 78% year-over-year
- Consumer Net Worth up 19%
- Another COVID Relief Package - $5.2 trillion in less than a year
- Continued positive momentum on the COVID front (cases, hospitalization, vaccinations -7-day rolling average above 2Million)
- Solid earnings growth
BUT, Market feels stuck in a loop –
- The economy strengthens – pushing bond yields higher, spooking equity investors.
- Fed buys more bonds (QE) to contain yields, pushing equities higher and strengthening the economy.
- Bond yields increase, spooking equity investors.
- Direction of the market and rates will largely be predicated by Fed rhetoric and messaging as the year progresses and their convictions are challenged.
Outside of volatility resulting from yield changes, we could see increased levels of trading and volatility around two events:
- Customary Institutional quarter end rebalancing:
- With the S&P up nearly 6% and small caps up about 20%, with bonds down around 4%, some rebalancing activity is expected to bring target allocations back in line.
- Quadruple "Witching" this past Friday (3/19):
- Options & Futures contracts for equities and indexes expire.
- Traditionally causes increased levels of volatility and price swings at the open and close.
From a technical perspective – investor sentiment recently hit historic extremes of optimism, flashing potential contrarian bearish signals:
- Put/call ratio – hovering around late 1990s levels.
- Equity Fund Flows – broken two monthly records since October.
- Fear/Greed Index off highs, but still at extreme levels
The $1.9 Trillion Relief Stimulus should start hitting bank accounts this week:
- With essentially $5 trillion in COVID relief stimulus which has resulted in checks of $1,200, $600, and now $1,400, consumer net worth up 19%, and the consumer savings rate still elevated, there would appear to be pent-up consumer demand.
- On average 36% of CARES Act stimulus went to savings, while 35% went to pay down debt.
- Right now, more than $1.7 trillion sitting in consumer savings, for a Savings Rate of about 13.7%.
- To put that in context, the last cycle average was 7.2%, so nearly double.
- Odds are as the economy reopens; we see the savings rate normalize in that 7-8% range.
- Plus, the newest round of stimulus.
- If January’s Retail Sales are any indication of the consumer’s willingness to open their wallets once stimulus checks are deposited
Inflation is expected to run hot:
- Most increased inflation numbers (both CPI and PCE) will experience increases over the coming months, mostly as a result of math.
- Base Effect as a result of essentially no inflation when the country was shutdown will naturally result in higher inflation year-over-year. This is expected by the Fed.
- Actual Inflation Numbers – Both CPI & PCE (CPI was 3/10) – Headline was slightly elevated, up 0.4% (mostly as a result of gasoline up around 7% and spiking energy costs resulting from the extreme February arctic temperatures). Core CPI was relatively unchanged.
- Key is will actual inflation meet current inflation expectations, or be more transitory?
- Base Effects and Commodity Gains
- Wage Pressure is a key input for sustained inflation, and right now there is a ton of slack in the labor market, and it’s still severely damaged, as evidenced by the 9.5M still out of work.
- February’s results were a positive to see after December’s decline, and January’s anemic growth.
- Yet in order to get the unemployment rate back towards the 4% level by the end of 2022, need to see an average run rate of about 400-500K per month.
- A stronger dollar (which we’ve seen as of late) will apply pressure on CPI food prices and other CPI goods more broadly (more lagged)
Fed Rhetoric and Messaging: How long will the Fed stay Dovish?
- With the newest Fiscal Stimulus Package, many expect GDP growth will be back to pre-pandemic levels by the end of the second quarter.
- Also, according to Morgan Stanley the economic impact will drive growth by year end to around 7.3%, which would be the highest rate since the Korean War Boom in 1951
- Fed revised their GDP Forecast to 6.5% for 2021
- PCE (inflation forecasts) were revised up to 2.4, 2.0, & 2.1 in 2021, 2022, and 2023, respectively
- Revised Unemployment rate to 4.5% by end of 2021
- Fed likely maintains current levels of accommodation in line with rhetoric for the foreseeable future, but the market will continue to challenge this rhetoric.
- Biggest key for the Fed is that all decisions will be based on “Actual” data, and not “Forecasted” data.
- QE (Asset Purchases) of $120 Billion/month through 2021
- Should “Actual” growth, inflation, and labor market performance exceed the current expectations, members of the FOMC (Fed) may become more hawkish and may result in normalization (tightening) sooner than expected.
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