Market Strategy 2/22/2021

Key Takeaways

• Last week the number of vaccinations jumped higher across the world and in the US, increasing expectations of an economic recovery later this year.
• Retail sales jumped 5.3% in January fueled by stimulus payments that the Congress enacted in December— far exceeding expectations of economists who expected a 1.1% rise.
• Q4 earnings growth for the S&P 500 continued to exceed expectations through last week, adding justification for recent equity price gains.
• 10-year Treasury yields rose to 1.34% on Friday, up 42 basis points since the start of the year, on inflation fears that in our view may well be unfounded. 

With almost 84% of the S&P500 companies having reported thus far in Q4 reporting season through last Friday, earnings are up 6.16% on the back of 2.69% revenue growth per Bloomberg data. Not too shabby we’d say, particularly as Barron’s reminded us this week that at the start of earnings season just weeks ago consensus had called for an 11% decline in earnings.

So far five of the 11 sectors in the broad market benchmark have posted double digit earnings growth for the period including: materials, consumer discretionary, financials, technology and health care. Two sectors have posted positive single digit growth (communications services and consumer staples) while two other sectors (utilities and real estate) have posted single digit negative earnings growth. The energy sector, reflecting the domestic and global impact of the pandemic over the course of the fourth quarter during which infections spiked in Europe and in the US, saw its member companies that have reported show losses steep enough so far in the season to list earnings growth as “not meaningful”. 

Results thus far in Q4 earnings season underscore the resilience evidenced among many companies through the pandemic, suggesting that much of the broad market’s gains have been justified.

On the vaccine front progress is becoming genuinely visible towards stemming the spread of the virus as the logistical hurdles experienced in the initial rollouts stateside and elsewhere around the world are addressed. Bloomberg’s vaccine tracker this weekend showed that some 205 million shots have been given worldwide across 92 countries. In the US nearly 65 million inoculations have been given so far.

Even as signs of progress against the pandemic rise in prominence, “what if” worries abound around the potential for virus variants to elude the current vaccines. Prominent vaccine developers and manufacturers appear confident that the existing vaccines or future variations on the vaccines will likely provide protection against mutant strains. We are reminded once again that wherever there is opportunity risk likely lies near and that wherever there is risk opportunity likely lies near. So far the efficacy of the most prominent vaccines being distributed around the world has raised confidence and improved sentiment at both the consumer and business levels worldwide. In our view, so far so good. Time ultimately will be the judge.

As the commodities markets, bond markets and the stock markets begin to discount the potential global economic recovery that likely lies ahead as Covid-19 and its variant kin get pushed into the rearview mirror worries about how much inflation the process of reflating the US and global economy might generate have grown.

Keeping the volatility typically inherent in the commodities markets as well as the potential for nervousness often found in the bond market in context appears to us to be the best course to follow at this time. Currently markets are navigating the transition from economies held hostage by the pandemic towards a process of economic revovery—eventally leading to sustainable expansions on a global basis. Such process will likely bring periods of resurgence and outsized growth that may represent economic reflation rather than prospects of untoward high inflation.

We counter the worries we hear about risks of levels of inflation high enough to cause the Federal Reserve (or other major central banks around the developed and emerging world) to “slam on the brakes” as unlikely due to long established vigilance by monetary authorities against inflation as well as secular trends tied to technology and globalization that are counter-inflationary. The latter include robotics on the factory floor, algorithms in the offices, the globalization of the labor force, strong competition among businesses, overcapacity within many sectors worldwide and an abundance of capacity to discover, process and deliver commodities worldwide (notwithstanding current bottlenecks caused in the short term by disruption to supply chains from by the pandemic).

Near-term Treasury bond prices are likely to remain under pressure as yields rise in anticipation of the economic re-openings that lie ahead. That said, in our experience the bond market has been known to project its expectations for inflation well beyond levels that are justified by the trends in the actual inflation rate.

As recently as 2018 the bond market over projected where bond yields were likely to normalize. Remember the 10-year Treasury at 3.11% in May of that year or its yield at 3.24% in November? Weeks later the price of the 10-year Treasury rallied to close the year at 2.69%, apparently on the realization that such a high yield represented how attractive it was to bond buyers rather than how far yields had further to go higher. The 10-year has not had a yield of 3% since 2018.

Looking back further in modern market history consider 1994 through the first quarter of 1995: a period wherein the Federal Reserve had raised rates convincing many market participants that rates would continue to rise through 1995. Yet it didn’t happen.

Once again time will tell. For now we’ll favor equities over fixed income, remain overweight US markets while maintaining meaningful exposure to international developed and emerging markets. Among the sectors of the S&P 500 we rate as outperform are: information technology, consumer discretionary, financials and industrials.

Related to market capitalizations we are near market cap agnostic finding opportunity among large, mid, and small equity capitalizations. In terms of style we opt to own a mix of growth and value companies as investor appetite broadens for equities and as the global economy moves towards economic recovery.