In our Global Market review 2021, we pointed to some downside risks for investors in 2021, nil climbing interest rates!
The message we receive from the bond market is the come back of inflation. The rising yield curve since a few weeks spell trouble for stocks.

The rising yield curve came with the announcement of Pfizer/Biotech in November that they had a Covid-19 vaccine. There is an expectation in the market that with people being vaccinated, the pace of global economic reopening will accelerate.

Two key economic releases last week fuelled enthusiasm about the economic recovery.  Case in point were the industrial production and retail sales releases.

The industrial production continues to improve for the fourth month in a row, but the year-over-rear change is not back in positive territory yet.

Retail sales was even more of a stand-out-significantly besting even the most optimistic of economists’ estimates.  Retail sales hit a new record high in January, of course helped by the latest round of USD 600 fiscal relief.  The recent strength is probably a preview of what’s to come after the passage of the “American Rescue Plan” currently being negotiated in Congress.

Existing home sales have clearly staged a V-shaped recovery.  The lack of supply continues to push prices higher, with an increase of 14,1% year-over-year of an existing home sold in January.
But consumer confidence shows no recovery.  Consumers’ assessment of current business and labour market conditions fell in January although expectations about the future outlook improved.  In contrast to consumers’ more dour near-term view, the CEO confidence has improved to a near-record high- and significantly higher than at any point during the 2009-2020 economic expansion.

So, is inflation next?
The PPI, producer price index, surged a record 1,13% in January, well above expectations.  Fiscal relief has boosted demand to a degree that has overwhelmed supply, which continues to be hampered by pandemic related supply chain problems and delivery bottlenecks.

On the contrary, Consumer Prices remain subdued.  Gasoline price increases drove headline CPI up in January, however, inflation more broadly, remains subdued.

What about the stock market?
The expectation remains for yields to keep climbing over coming weeks and months.  And a key question is how high yields need to be to dent stock-market returns.

Almost 70% of S&P500 companies pay a higher yield than the 10-year note.  That proportion will fall to 40% if companies keep their pay-outs at current levels and the Treasury yield rises to 1,75% by the end of this year (currently 1,46%).

That could start undermining the attractiveness of stocks as an income play.  Today the overall dividend yield on the S&P500 is 1,50% higher than the 10-year Treasury pay-out.  The implied long-term return of the S&P500 is around 3%.  Most strategists don’t expect the 10-year note to be able to challenge that return soon.

Goldman Sachs strategists wrote that a quick jump in Treasury yields would be dangerous for the stock market.  Real damage would require yields to rise 36 basis points in the span of a month. This looks unlikely.

So, bonds will likely become marginally more attractive in coming months, but it is not clear that such a shift will be enough to undermine stocks, especially as long-term bond returns are most at risk from rising yields. So, while Treasuries could provide a better alternative to stocks someday, that process could take longer than investors might think.

Stay tuned,

Vincent Weghsteen
Analyst Nucleus Group

2020 has been difficult in many ways, involving health scares, lifestyle changes and sadness for too many people. 

But in one important way, however, 2020 has been a good year with a powerful rally for US stocks, less for European stocks that were rather mixed.

Gold and the Metals sector have been the big winners with a return of 35% for Gold and 62% for Silver.  Commodities blossomed with a return of 26% for Copper, but the USD was one of the only losers.

The stock market has done well with the Nasdaq up 38%, the S&P500 up 14% and the Dow Industrials up 4,50%.

Most of the stock indexes hit new record highs and all signals are pointing to higher stocks, at least in the months ahead and probably longer. So despite  the big divergence between Wall Street and Main Street, it looks like the Fed’s super easy money policies will continue to push stocks even higher.

What are the biggest potential downside risks for investors in the year ahead?  While none of these scenarios make our base case for 2021, a review of the top investment risks in greater depth may be prudent as we enter the New Year.

With the vaccine rollout, the markets has high hopes for a successful and on schedule rollout of the Covid-19 vaccines globally, anticipating a majority of people having been immunized by July.  If delays comes around we could be in for a stock market pullback.

Geopolitically, there are mid-year presidential elections in Iran where we could see a hardline conservative come to power, hampering any US attempt to return to the Joint Comprehensive Plan of Action to contrain Iran’s nuclear ambitions. President elect Biden has made it clear he won’t be easing trade tariffs immediately and intends to confront China on environmental and labour issues in addition to intellectual property.  We can also expect renewed tensions between North Korea, Russia/Syria, Venezuela and others with interests in conflict with US goals.

Premature monetary or fiscal policy tightening in major economies could slow the recovery and deal a setback to the stock market.  This is what happened when the global economy emerged from the last recession in 2010 and 2011.

Lingering structural economic impacts from the 2020 crisis and recession could slow the economic rebound. Instead of a quick return to the pre-crisis economy, it is possible we may need a longer period of structural adjustment. Continued easy fiscal and monetary policy could also result in a drag on productivity and growth from the hordes of “zombie” companies. About 20% of US and non-US companies are considered “zombies”, defined as those with income insufficient to cover debt payments. These companies are being kept artificially alive with government aid.

Last, an unexpected jump in inflation, surprise surge in bond yields or plunge in the dollar might lead to higher stock market volatility. Don’t forget that inflation expectations have been rising fast the last couple of months.

 What are the markets telling us?

The market broke out to new record highs, signalling higher highs ahead.  Note that all of the stock indexes are clearly bullish, well above their 65 week moving averages.

Plus the fact that they are all at new record highs reinforces solid renewed strength across the board that will likely continue.

Ok, but what about the wide divergence between Wall Street and Main Street, the vulnerable economy, the new record Covid highs, business closing, many unemployed and so on?

While this is all true and the disconnect continues, there are two things we have to remember that were strongly reinforced this past month…

First, easy money has overpowered everything else. It’s been driving the market higher.  That’s what the market’s focused on and it’s thriving in this environment.  We have so much debt now, the markets are in such a massive bubble that the Fed would not dare risk pricking it. The Fed is not going to take away the “punch bowl”. (Peter Schiff)

Second, the vaccine news has also fueled optimism.  Keep in mind, the stock market always look ahead.  So perhaps it sees better times coming, say six months down the road.  This in turn is also helping to boost stocks higher.

Basically, all foreign markets are generally rising for the same reasons as the US market.  They like the stimulus, they are optimistic about the vaccines and they are happy the political situation has settled down.  Do not forget,  the markets like stability and here too, they seem to be looking ahead. 

So in conclusion:  Focus on time in the market – DO NOT TRY TO TIME THE MARKET

Vincent Weghsteen

Analyst Nucleus Group