Improving economy and stimulus drive markets to record highs
March 15, 2021
Equity markets look to extend their bullish run, as the S&P 500® Index and the Dow begin the week at record levels. Recent trends have accelerated the year-to-date variability of returns, with value (+11%) outperforming growth (flat) and small caps (+19%) beating large caps (+5%) this year. Equity markets shrugged off a continued surge in interest rates, with the 10-year Treasury at 1.63% on continued inflation worries.
The $1,400 stimulus checks to individuals began arriving in bank accounts this weekend, potentially accelerating the move of retail investors into the market. A Deutsche Bank survey found that online brokerage clients plan to invest 37% of their checks, while a Census Bureau survey showed that 15% of recipients would use money for savings and investments. Conventional wisdom says that this could drive the “story stocks” that dominated last year, though the $600 checks in January were coincident with a surge in small caps and value.
Flow trends are reflecting the recent market activity, with equities showing $41.5 billion of inflows in the most recent week, the ninth largest on record, while bond funds saw $15.4 billion of outflows, the largest in the past year. Outflows from bond funds are notable given the supply of Treasuries of $255 billion last week. The combination of record equity markets and aggressive flows has driven the average household’s equity market exposure to 24% of total financial assets, equal to the peak from the technology bubble, and the highest level since the 1960s. This, along with rising home prices is driving household net worth to record levels, up 10% from a year ago.
The upward shift in interest rates and expectations for GDP growth complicate the FOMC meeting this week. The most recent “dot plot” sees no change in the outlook for Fed Funds until at least 2023, but the Fed futures curve is beginning to price in earlier hikes as the outlook for growth improves. A survey of economists shows 75% expect a move by the end of 2023, with the curve embedding three hikes in that time. Inflation would likely be the trigger for hikes, and while inflation expectations have spiked, consumer price inflation remains well below the Fed’s 2% target.
The Biden administration’s ambitious “Build Back Better” addenda, along with the $1.9 trillion in stimulus have many debating what taxes are likely to increase in order to limit the impact on the deficit and debt. Advisors are focusing on the areas discussed during the campaign, including raising the corporate tax rate to 28% from 21% and removing other preferences that would largely undo the 2017 Trump tax cut. They are also expected to enact a more progressive tax code, including higher rates on those making more than $400,000 and higher capital gains rates on those making more than $1 million. Treasury Secretary Yellen said the administration has not decided on a wealth tax proposed by Senator Warren.
The relationship between the U.S. and China remains strained despite the transition to the Biden administration, with the FCC designating five Chinese companies as posing a threat to national security. Data in China reflect a strong economic recovery, with surging industrial production and retail sales. China was the first economy to enact restrictions to limit the Covid-19 outbreak and is now the first to unwind some of the resulting stimulus actions to control the overheating housing market.
What to Watch
All eyes will be on Fed Chair Powell, who will hold a press conference on Wednesday following the FOMC meeting. Economic data includes retail sales and industrial production on Tuesday, housing starts on Wednesday and leading indicators on Thursday.
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