Markets rally to start the year despite political turmoil
January 11, 2021
Equity markets continued their pro-cyclical shift in positioning, with equities beginning 2021 similar to how 2020 ended, with most indexes at record highs. Despite severe political turmoil this week, investors have opted to look beyond the current disruption and focus on the potential economic recovery, as markets have rallied 15% since election day.
Last weeks near 2% rally in the face of the events in Washington D.C., rising bond yields and signs that the economy is slowing was further evidence of the optimistic leaning of investors. Equity funds have seen record inflows over the past two months at nearly $200 billion, after showing $125 billion of outflows during last summer. The American Association of Individual Investors sentiment survey is at a three-year high. The Russell 2000 Index is the furthest above its 200-day moving average in history. The VIX at an elevated level (24) despite markets being at record highs and the put-call near record lows suggest options are being used offensively in addition to defensively. Historically, when momentum and sentiment indicators are this stretched, the market is due for a period of consolidation.
Nationwide’s Government Relations team notes Congressional Democrats changed their internal rules to allow spending on matters related Covid-19 relief or climate change without an offset in the form of tax increases and/or spending cuts, creating substantial flexibility. Democrats will also have substantial flexibility to determine what’s considered Covid- or climate-related, further reducing the pressure to raise taxes.
President-elect Biden is set to unveil his first Covid-19 stimulus proposal this week, with a potential price tag in the trillions of dollars. Included in his plan will include an incremental $1,400 check to individuals to hit the $2,000 target, expanded unemployment benefits, aid to state and local governments and vaccine distribution. Beyond the pandemic assistance, Biden plans to boost the federal minimum wage to $15 per hour from $7.25 and is considering an infrastructure deal of roughly $3 trillion via budget reconciliation rules that allow it to pass the Senate with a simple majority.
Interest rates continue to reflect the risk-on environment, with the 10-year Treasury yield above 1% for the first time since last March (see page 3 for detail). The yield curve has steepened, with the spread between the 10-year and 2-year at the widest level since 2017 at 0.98%. Federal Reserve officials are comfortable with the recent move, with Richmond Fed President Thomas Barkin saying, “I am encouraged to see the rise in market indicators of inflation expectations.” Given the current level of federal debt of $27 trillion (up from $9 trillion before the financial crisis), and the prospect for several additional trillion in near-term spending, rising interest rates could severely impact the budget deficit. Higher interest rates could also impose a headwind for equity market valuations.
Nonfarm payrolls surprisingly fell for the first time since April, losing 140,000 jobs in December versus an expected gain of 100,000. The unemployment rate was unchanged at 6.7%, as was the labor force participation rate at 61.5%. Leisure and hospitality employment sank by 498,000 jobs during the month after gaining 340,000 between October and November. Education and health services payrolls dropped by 31,000. The primary bright spot was wages, with average hourly earnings up 5.1% from a year ago. This shows that the economy likely stalled in its recovery during December. The Atlanta Fed’s GDPNow tracker sees the U.S. economy accelerating 8.5% for the fourth quarter, though economists expect the first quarter in 2021 to show either little or no growth.
What to Watch
Another busy week of economic data awaits, with NFIB Small Business and JOLTS job openings on Tuesday, CPI on Wednesday, import prices on Thursday, and PPI, retail sales, industrial production and consumer sentiment on Friday. Political noise will remain elevated, with an impeachment proceeding likely to begin.
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