Equity market strength continues, with gains in four of the past five weeks, and most major indexes at record highs. Leadership continues to broaden, with strength in the past month driven by emerging markets, small caps and value indexes. Despite incredible disruption, the S&P 500® Index is on pace to return 15% this year, which would be the 35th-best result in the 92-year history of the index.
Investors are facing clashing cycle indicators, as the unique conditions of the current cycle have created an environment reflective of both early cycle and late cycle conditions. The unprecedented drop in economic activity earlier this year drove the economy in recession, while the rapid decline in equity prices resulted in the fastest bear market on record. The speed of the economic and market recovery has been equally quick and impressive. Many current conditions are consistent with early cycle activity, including strength in value (+10% in past month) and small caps (+14% in past month), continued monetary stimulus, and a steepening yield curve. There are other conditions more consistent with a late cycle environment, including tight credit spreads and aggressive IPO (estimated $510 billion this year) and M&A activity. These dynamics are an example of how unique this cycle is, which will likely make the patterns more difficult to interpret.
Risk and sentiment indicators continue to tell an optimistic story, with the S&P 500 at the furthest above the 2000-day moving average since the financial crisis. Credit spreads are their tightest level since before the outbreak and put option buying is at a historic low versus calls. Sentiment indicators are expressing extreme optimism and equities are overbought, though counterintuitively, an overbought market has been a positive indicator for returns over the following 12 months.
Covid-19 cases continue to surge, with daily data showing 228,000 cases and 101,000 hospitalizations. The death total of 2,800 eclipsed the record from April. Shrinking hospital capacity is resulting in further mitigation actions, including a lockdown mandate in California and increased restrictions in many other states. The first Pfizer vaccines are set to be distributed as early as Friday, with as many as 24 million vaccinations by mid-January. The head of Health and Human Services said that all Americans who want to get a coronavirus vaccine should be able to do so by the second quarter of next year, though manufacturing and distribution challenges could arise.
The IPO market is remarkably robust given that we had a painful bear market less than nine months ago, highlighted by scheduled IPOs of Airbnb and DoorDash this week. EPFR data shows that companies plan to raise $510 billion in initial and secondary share offerings this year, exceeding the value in shares removed through repurchases and takeovers for the first time since 2009. Over the past decade, shares repurchased outnumbered IPOs by a three-to-one ratio. Merger activity is robust but repurchases are limited not only by balance sheet concerns, but also political pressure. As a result, cash holdings for U.S. companies rose to a record $2.1 trillion, led by several large technology companies.
Inflation expectations continue to adjust higher, with the 10-year breakeven inflation rate, a measure of the market’s expectations, rose to its highest level in 18 months to 1.86%, up from a low of 0.50% in March. The Fed has explicitly expressed that they will keep Fed Funds rate near zero until there is clear evidence of inflation. While market expectations for inflation have increased, official government releases continue to show little inflation (CPI and PPI will be released this week). There has been a notable deterioration in the dollar, with the trade-weighted index touching a two-and-a-half year low, which will marginally pressure inflation.
What to Watch
Work will continue on a stimulus deal this week, though challenges remain. Economic data include consumer credit on Monday, NFIB Small Business Index on Tuesday, JOLTS job openings on Wednesday, CPI on Thursday, and PPI and consumer sentiment on Friday.
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