To say investors embraced “risk-on” sentiment in the first quarter may be an understatement. Most risk assets and equity categories moved higher, with value stocks and small-caps posting the biggest gains. Growth stocks moved higher, but continued to face growing headwinds from rising interest rates. We have noted in previous commentaries that extraordinary stimulus measures could result in excess liquidity sloshing around the financial markets. More liquidity supports higher prices, but it can also push investors too far out onto the risk curve (cryptocurrencies, GameStop, etc.). We believe it is important to focus on quality and to avoid “chasing” in this type of environment. For March, the S&P 500 was up about +4.4%, and this index returned +6.2% in the first quarter.
President Biden signed the $1.9 trillion ‘American Rescue Plan’ into law on March 11. The bill includes direct payments to most American households, a significant expansion to the child tax credit, an extra $300/week in unemployment benefits through September 6, and billions of dollars across state and local education, Covid-related public health measures, and additional business loans.
There is plenty more in the bill. To appreciate the scope of direct payments, consider a young, middle income family with three kids. By qualifying for the stimulus checks and the child tax credits, the family could receive perhaps $15,000 from the federal government. In short, the bill is massive, and a majority of dollars are making their way into the real economy.
The labor market continues to show signs of stabilizing. In the last week of March, just over 714,000 people filed for state unemployment benefits, which was up slightly from the week before, but still marks drastic improvement since the pandemic began. Overall hiring accelerated for the month, with U.S. employers adding a seasonally adjusted 916,000 jobs—the strongest gains since August 2020. There are more job seekers entering the labor market and more job postings available, a good sign the recovery is gaining momentum. The unemployment rate fell to 6.0%.
The tanker blocking the Suez Canal made major headlines last month, putting additional stress on already strained global supply chains. The Suez Canal is responsible for facilitating about 13% of global maritime trade and 10% of seaborne oil shipments, making any delays meaningful. The Suez bottleneck was not the only problem in March—in the ports of Los Angeles and Long Beach, dozens of container ships were continuously waiting to offload medical equipment, consumer electronics, fuel, and other goods. These two California ports handle over 30% of U.S. container imports, which helps explain delivery delays and issues with inventory restocks in the U.S.
Perhaps the most acute shortages are being seen in the supply of semiconductors, initially caused by manufacturers being caught off guard by surging demand, as the U.S. economy began its sharp recovery last spring. Demand typically declines in recessionary periods.
Supply issues were later exacerbated by even stronger demand as global economies recovered, and were dealt a further blow by a serious fire at a Japanese semiconductor manufacturer—which will likely curtail supply for at least a month. Semiconductors are used in cars, and several automakers have been forced to halt production of various makes and models due to lack of essential components. The end result is that factories are reporting the sharpest rise in prices for inputs they’ve seen in nearly 10 years, which could add to inflationary pressures this year.
The 10-year U.S. Treasury bond started the year yielding 0.9%, and as of April 1 yields 1.7%. A growing economy and expectations for higher inflation—two conditions present in the current environment—could continue pushing rates higher. We have long expected interest rate ‘normalization’ as the economy shifted back into growth mode, so rising rates do not necessarily send off any alarm bells. Rates are still very low in a historical context.
Looking ahead, inflation may be of more concern. Inflation can be pernicious if it ‘runs away’ or is left unchecked—it can suppress growth in the real economy and diminish medium- to long-term return expectations in the capital markets. In the U.S., however, the issue of the last decade has been not enough inflation, so in the short-term, higher inflation would arguably be welcomed. In a testimony to Congress this month, Chairman Powell seemed to err on the side of not worrying: “[The Fed] might see some upward pressure on prices. Our best view is that the effect on inflation will be neither particularly large nor persistent.” He also added that the Fed, for now, remains strongly committed to accommodative policy given the economic recovery still has plenty of runway.
Should inflation become an issue down the road, it is important to remember the Federal Reserve has a range of tools to combat rising prices. Raising the interest rate it pays banks on excess reserves, reducing or ending bond purchases, raising the federal funds rate—these are just a few examples of policy decisions the Fed could implement to fight inflation.
There are also deflationary forces still at work in the U.S. economy. Technological innovation has lowered the prices of many goods and services over the last few decades, and aging baby boomers are entering a period in their lives when people typically consume less, which could be a drag on demand. The pandemic appears to be accelerating retirement for many boomers, which could be another neutralizing force on price pressures.
Apart from the recent surge in Michigan and slightly higher case numbers nationally, pandemic news was largely good throughout the month. Hospitalizations and deaths continued on a downtrend, and better weather has created more spending opportunities for consumers. Air travel is also returning to levels not seen since the early days of the pandemic, underscoring the eagerness of Americans to return to normal life. Stocks have been wavering between the ‘reopening’ trade and the ‘shutdown’ trade, as investors grapple with whether companies that benefited last year during the shutdown will be able to grow as strongly now that economy is reopening.
Our largest concern about the pandemic over the past few months had been the potential for another wave of infections to sweep the country, necessitating additional shutdowns. However, with the dramatic decline in cases from the peak as well as accelerated vaccinations, we now believe it is unlikely we will see another significant wave. This, in addition to the improvement in economic data we have seen over the past month, gives us more optimism looking ahead.
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