Markets remain volatile as economic data inflect higher
March 08, 2021
Equity markets were mixed in a volatile week, with the S&P 500® Index managing to break a two-week losing streak with a strong intra-day rally on Friday. Volatility remains elevated, with the S&P 500® Index showing directional moves of greater than 1% in six of the past eight trading sessions. The shift in leadership continues from large-caps, growth and momentum to small-caps, value and cyclicals. This year, the Russell 2000 Index is beating the Russell 1000 Index by 9%, while the Russell 1000 Value Index is beating the Russell 1000 Growth Index by over 10%. Many of last year’s stand-outs (Tesla, cannabis, solar, work-from-home companies) are in bear market territory.
Last year’s market strength was notable in that the backdrop included weak fundamentals, but substantial hope for an improving economy, fiscal stimulus, the vaccine launch and accelerating earnings. This year has seen many of those become a reality, resulting in strong fundamentals, but the equity market is experiencing directionless volatility because of fear of inflation, interest rates and equity valuations.
Interest rates continue to move higher on the outlook for better growth and the shift in inflation expectations. The sell-off in bonds has closed the valuation gap between equities and bonds, with the earnings yield on the S&P 500 (inverted P/E ratio) equal to the 10-year Treasury yield for the first time since 2010. The sharp rise in interest rates is testing the patience of the wave of investor flows into bonds in recent years, particularly with the highly liquid TLT ETF (iShares 20+ Year Treasury Bond ETF) down more than 12% this year.
Senate Democrats passed the $1.9 trillion stimulus bill along a party-line vote this weekend, including $1,400 checks to many individuals, $350 billion for state and local governments and enhanced unemployment benefits for an additional six months. Compared with the House bill, the income limit for the individual checks was lowered and the $15 minimum wage was excluded. Work now begins with the House to consolidate the bills, though House Speaker Pelosi has indicated they will agree with the Senate’s version. Passage is expected next week, and President Biden said checks will begin to be received this month. Given the reaction to the recent $600 stimulus checks, economic data should receive a boost in the near-term. As the attention shifts to infrastructure, swing Democrat Senator Manchin said he would not support a package under reconciliation, resulting in the need for bipartisan support and 60 Senate votes.
There are growing signs that the economic recovery is set to resume following a three-month stall. Job gains in February exceeded expectations, led by leisure and hospitality in a sign that the service sector is returning to work. Both the Services and Composite PMI are at the strongest level since 2014, driving the Atlanta Fed’s GDPNow model to show 10% growth in the first quarter, compared with the consensus of economists at 3%. The Citi Economic Surprise Index and Google mobility data recently touched their best levels since November.
The shift in inflation expectations is not only driving bond yields higher but is also putting a bid under commodity prices. The Goldman Sachs Commodity Index is up 20% this year to near the highest level since 2014. Crude prices are leading the rally, up 36% this year, and recently driven by hostility in the Middle East and the decision by OPEC+ to delay the boost in supply. Domestic supply is coming back online, with 309 oil rigs operating in the U.S., up from 172 in August, but a fraction of the 877 in early 2019.
Investor sentiment has deteriorated in recent weeks but flows into equity funds and ETFs continue to be strong. Goldman Sachs noted that equity inflows have totaled a record $163 billion over the five weeks since the start of February. Historically, rising rates have driven strong demand for equities. Demand for equities could drive upside, with an expected $350 billion in retail flows this year, along with a surge of merger activity and accelerated share repurchase activity.
What to Watch
Inflation data will draw attention this week with consumer price inflation (CPI) on Wednesday and producer price inflation (PPI) on Friday. Other notable releases include the NFIB Small Business Index on Tuesday, JOLTS job openings on Thursday and consumer sentiment on Friday.
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