Fiscal sticker shock
Will rising inflation and bond yields spoil the party?
Inflation and bond yields are the talk of Wall Street. Although benign in this week’s reports (more below), inflation is expected to jump reasonably soon with a Covid-fatigued, cabin-fevered, cash-rich American (global citizen, actually) releasing pent-up demand in 2021’s second half. What happens next is the debate. More than a few of my Wall Street sources see prices continuing to move up beyond those year-over-year (y/y) base effects, pushing bond yields up, too. A few think the 10-year Treasury will breach 2% by year-end. There’s just too much liquidity floating around, they say. Evercore ISI estimates $10 trillion of dry powder is waiting to be spent or invested ($2 trillion in personal savings above normal, $3 trillion of money supply above normal, a Fed balance sheet that’s $4 trillion above normal and a Treasury cash balance $1 trillion above normal). But there’s more! Incoming President Biden is proposing $1.9 trillion in recovery/pandemic relief (with a larger package slated for later this year), on top of December’s $900 billion installment and more than $2 trillion earlier last year. Chair Powell also vowed this week that the Fed isn’t even thinking about tapering its $120 billion in monthly bond purchases. “Now is not the time to be talking about exit.’’ If long yields do move beyond 1.5% or so on all this supply (the annual deficit is running well ahead of a $3-trillion pace, more below), that could be a problem for stocks. It would undercut P/E multiple expansion, a factor that helped drive prices to records last year. The hope, reinforced by Powell’s comments, is the Fed would step in with yield control. Otherwise, the risk-reward for stocks could suffer.
If rates drift higher, earnings would have to do the heavy lifting. Deutsche Bank equity strategist Binky Chadha, who was convinced consensus on U.S. earnings going into the last two earnings seasons was far too low and was proven correct, feels the same about the Q4 season that got underway this week. Corporate fundamentals are on surprisingly solid footing, and after declining some heading into the fourth quarter, earnings and sales net guidance have started to move higher. Unusually robust analyst revisions point to further upside, as do strong ISM manufacturing readings, which historically are highly correlated with beats. Eighteen early reporters with November year-ends beat 12.4% on average. Strategas Research sees continued signs of cyclicality everywhere it looks. Microcaps are in the midst of a record momentum surge and are now outperforming the Russell 2000, which is outperforming the Russell 1000, which is outperforming the S&P 100. Renaissance Macro is encouraged by the recent spike in 52-week highs and the failure of high momentum names (2020’s winners) to dominate performance over the last 65 days. Historically tops form not with a high number of 52-week highs but a non-descript mediocre number. They also tend to form when momentum and beta are dominant, not when momentum is in the bottom decile of historical performance as is the case today. Valuations do appear stretched, and sentiment and technical indicators are signaling stocks are between “frothy” and “too far over their skis”–80% are above their 200-day moving average. These signs often precede a market decline. But as it’s still early cycle, any pullback should be viewed as a buying opportunity.
Comparisons with 1999/2000 are popular but neglect a key variable—the market remains a heck of a lot broader today versus the S&P 500 peak in March of 2000. Even Energy is an uptrend and Financials are challenging their early-2007 price highs. The S&P forward P/E rose to a record 25.7 during the week of July 16, 1999, versus 22.9 a wek ago. The forward P/E of the S&P Technology sector peaked at an all-time high of 48.3 during March 2000, versus 27.7 a week ago. And those earlier P/Es were achieved when the 10-year yield was around 6%, versus 1.12% a week ago. Perhaps most noteworthy, the economy back then was on the verge of recession. Today’s economy is in the early stages of recovery. As vaccines roll out (daily inoculations closed in on 1 million this week) and people cooped up for months cut loose, their pockets overflowing from the biggest-ever increase in consumer net worth, rising wages (more below) and a perpetual flood of stimulus relief, the economy is almost certain to experience its biggest growth spurt in a generation. I know where I’m going. Forget the heels. Southern Florida’s still got a few snowbird homes on the market.
- Signs of a V Industrial production surged a broad-based 1.6% in December, its largest gain since July, pushing production increases for the fourth quarter above an 8% annualized rate. Manufacturing rose an eighth straight month despite a drop-off in autos, where chip shortages have curtailed output.
- Signs of a V Evercore ISI’s trucking survey, which has a high correlation with GDP, held at a 15-year high, while the OECD U.S. Composite Leading Indicator increased an eighth straight month to near its highest in a year.
- Should we really be worrying about inflation? Despite spiking oil prices and rising prices for other fuels and food, the core inflation rate held at a 1.6% y/y rate for the third straight month in December. Core producer prices slipped to a 1.2% y/y rate.
- The recovery’s shape ultimately will be determined by consumers … Retail sales fell a third straight month in December as the Covid crisis and reemerging lockdowns weighed. Credit card data suggest the slowing continued into the new year, as did the Bloomberg Consumer Comfort Index, which declined an eighth straight week to a 6-month low. Despite the extension of jobless benefits and stimulus checks to most households, the personal finances component dropped to its lowest level since last May. Michigan’s initial read on January consumer sentiment also slipped.
- … and by jobs Initial jobless claims surged by the most since last March to their highest level since August as layoffs sped up at the start of the year on rising Covid cases and partial shutdowns. The Labor Department also reported job openings fell in November.
- Small businesses don’t like talk of taxes The NFIB optimism gauge sank to a 7-month low even as a record number said inventories were too low, a positive for future production. Renaissance Macro noted the gauge is out of sync with other sentiment surveys and often gives off signals reflecting the partisan biases of respondents. With Biden winning, 21% cited “taxes” as their single-most important problem, a 3-year high.
It’s an MMT world On a 12-month total basis, the deficit rose to $3.35 trillion, a record 16% of GDP. With the latest Covid relief bill signed into law and trillions more on the way, the budget deficit should continue to swell. In December, federal outlays increased a record 50% y/y, while receipts fell 2%. Even so, net interest payments declined almost 9% on a y/y trend basis, thanks to record low interest rates.
More for the piggy bank Instead of softening as is typical during slumps, wage growth has maintained its pre-pandemic pace of +3%, even after accounting for disproportionate layoffs among low-wage workers in establishments hit hard by the virus. This likely is because wages have continued to rise in industries where demand has remained strong or even accelerated, and because a high share of laid-off workers are putting off job searches due to the pandemic.
Mainstreaming sin With New York seemingly on the verge of joining 11 states and D.C. that have legalized possession of recreational marijuana and 14 and D.C. that have legalized online sports betting, Strategas has developed what it calls its SINDEX of companies most poised to benefit from the political class’ inexorable need to find other sources of tax revenue—in particular, online sports betting and cannabis stocks. Since the subject of sin can be subjective, it also provided a list of companies that might represent the seven deadly sins of lust, gluttony, greed, sloth, wrath, envy and pride.