News of faster-than-expected vaccine distribution in the U.S. and the Federal Reserve’s pledge to keep rates near zero through 2023 were a shot in the arm for stocks last week. But inflation fears resurfaced, driving Treasury yields up and sparking a tech stock sell-off.
Lagging tech shares are one reason the past few years’ status quo has flipped and the S&P 500 index is trailing the Dow Jones Industrial Average in 2021. On a total return basis, the Dow is up 7.9% for the year through Thursday, March 18th, while the broader S&P index has gained 4.6%. The MSCI EAFE index, a measure of developed international stock markets, has returned 5.0%. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.62%, up from 1.51% last week and 1.12% at the end of 2020. The U.S. bond market has declined 3.7% this year.
Fed Steady; Inflation Concerns Persist
We often say that markets move on earnings and interest rates; everything else is noise. Well, interest rates were front and center this week, as the Fed once again made a commitment to stay the lower-for-longer course. That didn’t fully calm bond traders, who sent the yield on the benchmark 10-year Treasury to 1.74% on Thursday—a brief return to pre-pandemic levels.
Why are bond market denizens seemingly ignoring the tried and true aphorism, “Don’t fight the Fed?” In part, they’re concerned that a recovering economy, flush with stimulus cash, will spur rising inflation, possibly even forcing policymakers’ hands.
But are these inflation concerns warranted?
While we expect inflation rates to increase as the year rolls on, we are not convinced that a post-pandemic inflation spike will persist and stymie long-term economic growth. Yes, there are some temporary supply chain issues that are causing price distortions, but we aren’t seeing sharp, widespread, growth-choking inflation. Plus, with the job market still in a fitful recovery—new claims for unemployment benefits rose slightly last week after several weeks of decline—we think bracing ourselves for inflationary times is getting ahead of where we are (and where we are headed).
Rather than a negative, inflation is good for businesses and investors so long as it doesn’t overheat. For one thing, it reduces the impact of long-term debt on both companies and the economy. For another, it’s an indicator of growth rather than contraction. And, over the long run, owning businesses with growing earnings and cash flows has been one of the best ways to protect against inflation—so a diversified portfolio already has some inflation defense built in.
Robust Economic Growth? Wait and Watch
The Dow and the S&P 500 indexes both hit multiple record highs this week. And why not? Shots are reaching arms, businesses are reopening their doors and $1.9 trillion in fiscal stimulus is being injected into the economy.
Does this mean economic growth is about to go gangbusters? Well, maybe down the road. But economists’ expectations for first-quarter growth, so lofty just a month ago, are quietly being rolled back to a more modest level.
The Federal Reserve banks and companies like Moody’s keep tabs on all kinds of economic indicators, some of which are reported monthly and others much more often. Based on the data, their high-frequency models for economic growth have been getting less optimistic as March rolls on.
The Atlanta Fed, for instance, was predicting in late February that the economy would grow at an annualized 9.6% rate and they ratcheted that up to 10% in early March. But, just yesterday, their estimate came in at 5.7%. That’s a major revision—suggesting that growth would be 1.4%, quarter over quarter, rather than 2.4%. They’re not alone. Moody’s took its estimate down from an annualized 8.1% rate to 6.4% over the past week—it had been as high as 9.0% in February.
Why is this important? It’s simple: Economic growth ultimately drives profit growth. If companies see good profit growth, then today’s stock valuations—and record-high stock prices—may not be unreasonable. Without a robust economic recovery, the market’s road ahead will be more challenging.
Federal Tax Deadline Extended
The Internal Revenue Service (IRS) announced Wednesday that it is extending the 2020 federal income tax filing deadline from April 15 to May 17, 2021 for individuals.
But before you hang up your green eyeshade and put your tax forms back in your “to do” pile, be aware that the extension doesn’t apply to everyone.
As of this writing, the IRS announcement applies only to complete 2020 tax returns. If you file quarterly estimated taxes, well, your deadline has not been extended, and the first payment for 2021 is still due April 15. If you’re planning to take advantage of the extension, be sure to find out if your state has followed suit. Many states have yet to issue guidance in response to the IRS’ announcement and may still require you to file your state tax return by April’s deadline. We expect the IRS to issue further guidance in the days to come. Be sure to reach out to a tax professional if you have questions about your taxes.
Consumers Primed to Spend
The consumer is the lifeblood of the American economy. And during this year of stubbornly high unemployment, we’ve seen how stimulus checks spur some people to spend. After the $600 payments from December’s legislation landed in bank accounts, consumer spending rose 2.4% in January—the steepest increase since June.
But people aren’t just spending, they’re also saving. Households saved 20.5% of after-tax income in January, up from 13.4% the previous month—the highest rate since May 2020 (and pre-pandemic, the highest rate since World War II).
Sure, some of that was belt-tightening after the holiday shopping season. And much of it came from households with the most discretionary income cutting back by cooking at home and canceling vacations.
Yet it’s not just the well-to-do who have been saving. According to a JPMorgan study, through October 2020, the median checking account balance for families in the lowest 25% of incomes was up 50% from the same time in October 2019—a figure directly attributable to the first round of stimulus payments made in April 2020.
With luck, the ARP is the final shot in the arm that gets our economy through the last of the severe COVID-19 restrictions. Consumers are more flush than we’ve seen in generations—and spending in the back half of the year could help create an economy that’s off to the races.
Lastly
-Sales at the retail level plunged 3.0% in February after stimulus payments helped drive sales up 7.6% the previous month. Nevertheless, retail sales are 6.3% above their February 2020 level. Most businesses experienced a drop in sales, with the largest decreases occurring in sporting goods, hobby, musical instrument, and book stores (-7.5%); department stores (-8.4%); nonstore (online) retailers (-5.4%); and motor vehicle and parts dealers (-4.2%). Sales at gasoline stations increased 3.6% last month — the only major retail business that posted a sizable monthly gain. March is likely to see a surge in retail sales following another round of stimulus checks. Despite the dip in February, for the 12-month period ended last month, the majority of retailers saw an increase in sales.
-Industrial production fell 2.2% in February after increasing 1.1% in January. Manufacturing output and mining production fell 3.1% and 5.4%, respectively, while the output of utilities increased 7.4%. Overall, total industrial production in February was 4.2% lower than its February 2020 level.
-After surging over the past several months, both housing starts and issued building permits lagged in February, according to the latest information from the Census Bureau. Privately owned housing starts were 10.3% below the January estimate and 9.3% lower than the February 2020 rate. Building permits for housing units also fell, down 10.8% from the January rate but 17.0% over the February 2020 level. Last month, housing completions were 2.9% higher than the January figure and 5.0% above the February 2020 estimate.
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