Equity markets retreated from the record high set last Wednesday after a spike in interest rates and a rebound in cases in Europe cast doubt on the global economic recovery. Investors’ mindset is beginning to shift from optimistic to skeptical as many of the catalysts that have driven the S&P 500® Index’s 77% return from the March low (reopening, vaccine, acceleration in earnings, stimulus, etc.) have now been realized. With earnings season a month away, markets lack a near-term catalyst, potentially leading to volatility.
Treasury yields will continue to be in focus with $180 billion in Treasury issuance this week. The 10-year Treasury yield has risen for eight-straight weeks for the first time in 17 years, reaching the highest level in over a year. The yield curve is at the steepest level since 2015. The Fed is watching developments closely, though a decision by the Fed to suspend a pandemic-era rule that allowed banks to relax capital rules is forcing the sale of Treasuries. While credit spreads remain tight, other indicators of liquidity, including the TED spread and commercial paper spreads are at multi-month highs.
The supply and demand balance of equity shares is beginning to shift in favor of the bulls, with equity funds showing inflows of $347 billion to date in 2021. This already eclipses the previous full-year record of $295 billion in 2017. Additionally, share repurchase activity is accelerating, with cash on the balance sheet of S&P 500 companies at $2.2 billion. While IPO activity remains strong, merger and acquisition activity will largely offset. If the demand for equities this year outweighs supply by roughly $2 trillion, it would equate to more than 6% of the $32 billion market cap of the S&P 500, acting as a tailwind for returns.
Economic data continues to improve as the economy reopens, with time outside the home down 9% from pre-pandemic levels, the best level since October, led by a strong bounce in retail and restaurants. More employees have returned to the workplace than at any time since the lockdown. Consumers have a tremendous amount of “dry powder” to spend with elevated savings levels and recent stimulus checks, which could be spent as the weather improves and mobility data improves. The Atlanta Fed’s GDPNow model currently predicts 6% growth in the first quarter.
Covid-19 data continue to improve, with cases down 78%, hospitalizations down 73% and deaths down 68% from the January high. The AstraZeneca vaccine showed 79% effectiveness in preventing symptoms and 100% effectiveness in avoiding severe outcomes in a U.S. study. This followed news that several countries suspended use following reports of blood clots, though many have resumed use. It could join the three other vaccines with a emergency use authorization next month.
The Biden administration is determined to boost taxes on the wealthy to fund an ambitious infrastructure package. Support for the plan is unlikely from Republicans, driving the need to act unilaterally. The taxes would include income and capital gains on families making more than $400,000, along with higher corporate income taxes and the expansion of the estate tax. The driver of the administration policy is the fact that the top 1% of households added more than $4 trillion in wealth over the past year, while the bottom 50% added less than $500 billion.
What to Watch
Fed Chair Powell speaks to the Bank of International Settlements on Monday and joins Treasury Secretary Yellen in congressional testimony on Wednesday. Economic data this week include existing home sales on Monday, durable goods and PMI data on Wednesday, revised fourth-quarter GDP on Thursday, and the PCE deflator, consumer income and spending and consumer sentiment on Friday.
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