Published on Mar 8, 2021
February 2021 | Equity Commentary
Stocks rallied in the first half of February, with both the S&P 500 and the tech-heavy Nasdaq posting fresh all-time highs. Stocks were ushered higher by a strong Q4 earnings season and progressively better news regarding the availability and administration of vaccines. However, equities felt pressure later in the month from rising Treasury bond yields, which generally tends to drive volatility in high growth/high valuations stocks. The Nasdaq’s performance in February reflected the dynamic between bond yields and stocks—the index gained more on the upside during the month, but also lost more on the downside. We expect this type of volatility to persist until the market has fully adjusted to the new level of rates. In spite of the choppiness, the S&P 500 still finished February with a gain of 2.8%, while the Nasdaq finished up 1%.
By the beginning of March, nearly all companies in the S&P 500 had reported quarterly earnings, and the results were good. 77% of companies reported positive earnings and revenue surprises, with an average earnings surprise of +16%. If 77% holds, it would mark the third-highest percentage of positive earnings surprises in 12 years.
S&P 500 companies also generally raised guidance for current and future quarters, a sign that boardroom sentiment is improving. Bloomberg estimates that S&P 500 companies ended 2020 with around $2.6 trillion in cash reserves, the highest level since 2013. If the pandemic risk continues to fade and the economy pushes along the path of recovery, there’s good reason to believe some of this corporate cash buildup will be returned to shareholders in the form of dividends, buybacks, or both. We may also reasonably expect higher levels of private fixed investment, a trend which is likely to boost economic activity in the coming years.
More fiscal stimulus is on the way. The House of Representatives has already passed a version of the Biden administration’s $1.9 trillion American Rescue Plan, which includes another $1,400 in direct stimulus payments, an additional $1,000 child tax credit, and an extension of unemployment benefits to August 29. The Senate passed its own version of the bill, which the House can consider, but the price tag is not likely to change. While we still believe $1.9 trillion may be overkill relative to the current economic situation, it is difficult to make the case that additional stimulus will hurt stocks or the economic recovery in the near- to medium term. There’s the old saying that investors should not “fight the Fed.” We think that investors should not fight the federal government, either.
It is quite possible that all of the extraordinary monetary and fiscal policies, taken together, could drive inflation higher. All three Covid-19 stimulus packages featured transfer payments made by the government directly to American households and businesses, in the form of stimulus checks, expanded unemployment benefits, PPP loans, and other small business loans which effectively became grants. The M2 money supply is rising at an unprecedented 25% year-over-year rate.
Inflationary pressures are already starting to show up in the commodities markets and in US Treasury bond yields. The price per barrel of crude oil has rallied +30% year-to-date, copper prices are +50% over the past year, and the cost of shipping freight is up over +200% over the same period. Lumber prices have also doubled over the past year on the heels of a housing boom, adding materially to the cost of a new home. It seems the debate is no longer whether we are stuck in a deflationary pattern, but rather how much inflation could surprise to the upside.
While higher inflation in 2021 and beyond is certainly a rising possibility, it is not a foregone conclusion. Other conditions that tend to spur higher inflation—such as tight job markets and a lack of spare capacity in the economy—are currently missing. We believe the real risk with inflation is that it also raises the risk of monetary tightening, which could inject volatility and weigh on valuations across the capital markets. The upshot is that the Federal Reserve is more transparent than ever, with very clear and frequent forward guidance being offered to the markets. We think it is premature to expect this Federal Reserve to change course any time soon, as recent minutes indicate no appetite for monetary tightening in the near-term.
Pandemic data continues to improve. The average number of vaccine doses eclipsed 2 million per day for the first time beginning on March 3, underscoring improvement in the campaign’s organization and execution. At the beginning of February, the daily average was about 1.3 million. We expect the figures should only get better from here, as the Johnson & Johnson vaccine was cleared by the FDA, and as Pfizer and Moderna both increased production. The federal government also scored a victory by brokering a production deal between Johnson & Johnson and Merck, two companies that are otherwise rivals.
We continue to be concerned about variants of the virus, as there is little data to date about the vaccine’s efficacy against new strains. Of particular concern is the P.1 variant discovered in Brazil, which early data suggests is more contagious and may have the ability to infect even those who have already had Covid-19. All signs point to the vaccines being strong enough to mitigate the onset of an entirely new pandemic, but more data is needed to understand the scope of the risk.