I wonder, though ...
What if Biden gets most all of what he wants? Is the market ready?
Manufacturing and services are on a tear (more below), housing is booming, Google search and credit card data show hospitality spending starting to normalize (in eight states, restaurant seatings are above pre-pandemic levels!), and the labor market is healing as fast as needles are getting into arms. Seldom does the market stumble when fundamentals are so strong. But with another week of new highs, how much is priced in? Consensus keeps pushing up GDP growth and earnings forecasts as Q1 earnings season is upon us. I wonder, though. With the ratio of S&P 500 market cap to money supply above the pre-crisis average, the market may already be accounting for additional stimulus. And over in bond land, the yield curve is virtually unchanged since mid-March. Is it beginning to see clouds on the 2022 horizon? Growth in the next few quarters seems set to be some of the best in generations. But what about after that? The proposed corporate tax increases may hit harder than a lot of investors think—my Wall Street sources say its focus on overseas earnings hasn’t been fully appreciated and could push the effective U.S. corporate tax rate far above our developed-market peers.
Despite the run-up in stocks, the global equity risk premium—the forward equity earnings yield minus the real bond yield—still stands at about 6%, similar to where it was in late-2009. Momentum no longer is expensive and is trading at a discount to the market, with its composition having shifted massively toward value stocks while growth stocks have largely been flushed out. With risk-reward no longer stacked against growth, JP Morgan expects it to at least perform in line with the market as participation broadens with value continuing in the lead role. I wonder, though. Hedge funds and institutional investors continue to be reluctant to buy cyclical stocks. Bank of America says its clients’ cyclical exposure is the lowest in decades; Morgan Stanley clients are paring such exposure, too. This may reflect the view among some that economic momentum could peak over the summer. But Fundstrat says that doesn’t necessarily translate into a top for cyclical stocks. Many cyclical companies have undergone dramatic cost cutting, making for substantial operating leverage. Moreover, the VIX is sinking and credit markets still favor “cyclicals,’’ i.e., high yield over investment grade, a sign of faith in the economy and the value trade. One way or another, the U.S. is looking to pass a massive infrastructure program to make up for nearly 15 years of disinvestment. That will require a lot of materials and labor and finance that cyclical companies can provide. I wonder, though. Infrastructure spending takes place over numerous years, but tax increases are immediate (and sometimes retroactive).
The question is whether durable drivers of growth exist to carry the expansion beyond its pent-up demand-fed, stimulus-backed, liquidity-driven surge? Strategas Research isn’t sure, and it’s not alone. Investors recently have pulled away from the intermediate-term cyclical positioning that defined last year’s second half and the first two months of this year—value over growth, small over large, international (non-U.S.) over domestic—and have adopted a more “wait-and-see” stance. After the election, most observers concluded the narrow Democratic House majority and the 50/50 Senate would force Democrats to trim President Biden’s ambitious progressive agenda. I wonder, though. Over the course of a year, Congress enacted six laws that provided over $5 trillion in “pandemic-related” funding. With a much quicker and stronger economic recovery than expected, most observers have concluded that the massive American Jobs Plan (aka the “infrastructure” plan, which includes roads, bridges, waterways and other transportation, other infrastructure such as broadband and the electrical grid, and non-traditional infrastructure such as home- and community-based health and elder care) and pending American Families Act will be dramatically watered down. If for no other reason than that midterms are right around the corner! Instead, the Senate parliamentarian’s ruling clears the way for widespread use of budget reconciliation and a simple majority vote. The administration is emboldened. Biden likes the media comparing him to FDR and LBJ. And conservatives are pinning their hopes on Joe Manchin. I wonder, though.
- Services surge The ISM gauge of nonmanufacturing activity jumped to a record high in March, and the companion Markit services index rose to nearly a 7-year high, as activity boomed amid more vaccinations and more easing of Covid restrictions. It was the second-biggest monthly increase in the ISM since the series began in 1997, with all 18 industries reporting growth.
- Jobs will determine how fast we grow Citing March’s strong rebound in its Employment Trends Index, the Conference Board said it expects "historically fast employment growth in the coming quarters," with the unemployment rate falling to 4% a year from now and declining further afterward. Job openings continue to climb, although in a troubling aside, employers say many skilled positions are going unfilled.
- Regime change? The word “taper’’ never appears in the Fed’s March meeting minutes, suggesting a greater “stay on hold” consensus within the committee than implied by the dot plots. The forward inflation curve indicates 2.5% inflation over the next 10 years vs. 1.8% the prior 10 years, a backdrop that favors deeper cyclicals, lower correlations and a lower equity risk premium.
- Old news March headline PPI jumped 4.3% year-over-year (y/y), with energy the big contributor, while the core rate climbed a more moderate 3.1% y/y. Both overshot expectations but we’re in the “base effect” zone, with year-ago crisis data impacting this year’s y/y measures. Today’s commodity prices have generally stabilized, reflecting the post-global V-rebound moderation and recent dollar stability.
- I’m watching the dollar February’s trade deficit widened to a new record on the growth divergence that’s buoying imports to meet growing U.S. demand while depressed global growth weighs on U.S. exports. The large U.S. twin deficits (the other record fiscal red ink) are hardly dollar friendly.
- A hidden drag on housing While higher mortgage rates and prices get cited, a key factor holding back housing’s surge is historically low supply relative to the total number of U.S. households, in large part because of restrictive zoning laws in many desirable locations that make it difficult to construct new homes.
It’s raining money Americans are saving their stimulus checks, socking away 42 cents of every dollar received from the third round of pandemic aid sent out in March, according to a New York Fed poll. Less than a quarter of the funds, which average $3,162 per household, are being spent and the remainder is being used to pay down debts.
Herd immunity? The U.K. is on pace to achieve herd immunity next Monday, making it the first major nation to do so. According to the epidemiological modelers (who have gotten everything else wrong so far), it will have done it with a one-shot-for-everyone strategy, distinct from the U.S.’ two-shots-for-the-vulnerable approach.
Do you wonder, too? Strategas sees little impetus on the part of policymakers to curtail what it views as profligate fiscal spending. It thinks this insistence for “more” spending to fill economic potholes, both actual and imagined, carries the potential of creating a similar environment of fiscal resource misallocation as was seen in the 1930s and the 1970s. It’s doubly troubled by the Fed’s seemingly casual indifference to combat the concomitant effects of rising inflation.