Published on Feb 8, 2021
January 2021 | Equity Commentary
Stocks began the year with modest declines, as the S&P 500 fell by just over 1% during January. Investors continue to wrestle with the crosscurrents of the ongoing Covid crisis and its economic implications on the one hand, and copious amounts of fiscal and monetary stimulus on the other. While risks remain elevated, we are optimistic that the ongoing vaccination efforts can go a long way toward restoring a semblance of economic normalcy over the next several months.
Economic data has been mixed in recent weeks. Industries which tend to be more exposed to the pandemic, such as travel, leisure, and entertainment, have struggled, while more insulated areas of the economy have fared better. The December jobs report was illustrative of this dichotomy, as in the aggregate the economy shed 140,000 jobs, but strip away the 372,000 losses in restaurants and bars, and the rest of the picture appears brighter. The majority of industries added jobs during the month, and the unemployment rate held steady at 6.7%. Retail sales have weakened of late, as December marked the 3rd consecutive month of sequential declines. It is likely no coincidence that this weakness has transpired during a period in which Covid cases were rising precipitously. While the pandemic has impacted many businesses negatively, the housing market has been a notable exception, as it has benefitted from both deurbanization and nesting trends, as well as the historically low mortgage rates available in the aftermath of the Federal Reserve’s interest rate reductions and asset purchases. Single-family starts and permits were quite strong in December, just the latest in a long line of healthy housing market indicators over the past several months.
The Federal Reserve held its latest FOMC meeting last month, and our takeaway is that the committee remains quite dovish. The Federal Reserve downplayed near-term inflationary concerns and reiterated that it remains premature to begin tapering asset purchases. Its base case for the economy is that strong growth is likely to resume as vaccines become more widely available, though it noted the downside risks associated with a slow initial vaccination rollout and new Covid variants. In our view, the Federal Reserves’ risk assessment is more heavily weighted towards the near term, while its longer-term outlook is more bullish. We therefore think it is all the more important that Congress was able to pass the most recent $900 billion fiscal stimulus bill at the end of December, and we believe that more aid will be forthcoming with Democrats now in charge of the executive and legislative branches. Historically, the central bank has been prone to tighten policy in response to financial market instability, and in this regard, there was some concern that froth in certain pockets of the market might force the hand of the Federal Reserve. Federal Reserve Chairman Powell, however, allayed these concerns by making it clear that he is far more concerned with achieving his goal of maximum employment, the implication being that monetary policy is likely to remain highly accommodative for the foreseeable future.
President Biden recently proposed a $1.9 trillion fiscal stimulus plan, which is largely comprised of increased unemployment benefits, additional stimulus checks, support for state and local governments, and funding for coronavirus vaccinations and testing. Republicans have most recently countered with a $600 billion proposal of their own. While Democrats could use the budget reconciliation process to enact much of $1.9 trillion in support that they are seeking, President Biden has suggested that his preference would be to work with the GOP to reach a mutual agreement. Ultimately it appears highly likely that some degree of incremental stimulus will be passed. With today’s economy being significantly stronger than it was last year when the CARES act was enacted, we do not think that the full $1.9 trillion is necessary. In our view, any amount in between the range of the two proposals would be sufficient to support the economy and satisfy capital markets. We are cautious, however, that inflation could create challenges over the long term. Over time, as the economy fully reopens, the release of pent-up demand alongside of the lagged effects of historic amounts of fiscal and monetary stimulus could unleash a powerful growth phase. This could drive inflation higher and take bond market yields with it, creating a less favorable environment for stocks, in our view.
Covid remains a key risk factor for the economy and capital markets. The path of the pandemic will likely dictate the future course of the economy, and in this regard, we are concerned with the latest variants of the virus which may be more highly transmissible, and perhaps less vulnerable to the current generation of vaccines. It is therefore not out of the realm of possibility that we see yet another wave of infections, perhaps during the spring. That being said, it does appear that vaccines remain effective in reducing worst-case outcomes from the new coronavirus strains. That could make a potential next wave less problematic for the economy, as we assume that policy makers would be less likely to impose additional lockdowns if there was a lower probability that the health care system would be overburdened without them. While risks remain elevated, we are optimistic that between the vaccinations currently being administered, and those in various phases of development, that the resources are available to foster a return to normalcy over the near to intermediate term.