Market Commentary - January 2021

Monthly Update

The S&P 500 started out 2021 strong but ended the month weak with a net result of being down 1.1%[1]. The tech heavy NASDAQ was higher by 1%, while the Russell 2000 added to its late year 2020 strength with a 5% rally[2]. Interest rates broke out to the upside, with the 10 yr yield finally recapturing the 1% level for the first time since February. It started January at .92% and ended at 1.07%, while getting as high as 1.19% intra month[3]. After falling for 7 of the past 9 months, the euro heavy dollar index bounced by .7%, coincident with the rise in interest rates[4]. Commodity prices continued their strength, up by 3.8% and reinforcing, in my mind that inflation is here and will accelerate further in 2021[5]. g

Just because the calendar flips to another year does not mean that there is any change in the opportunities and challenges which lie ahead. With the vaccine rollout ramping up in the coming months, we have a lot to look forward to as we put this virus in the rearview mirror. The road won’t be easy though, as different variants flare up and it could take the remainder of the year for the rest of the world to get vaccinated. I’m hopeful that the US is about 4 months away from some form of herd immunity. This is based on the expected shot rollout, which is picking up, on top of the confirmed number of Covid cases, as well as making an assumption on how many got the virus but were never accounted for.

As for the economy, as the vaccine rollout goes, so goes a broader reopening. Leisure, hospitality, and travel have been the hardest hit over the past year, and they will benefit the most upon the reopening. Housing and manufacturing have been the bright spots and should remain so. That said, we do expect consumers to shift the majority of their spending back to services from the goods side.

The Federal Reserve and its easy money policy has been the main underpinning to markets and that will continue for as far as the eye can see. You can be sure they will take their time in removing any of their 2020 easing steps. On the fiscal side, the Biden administration has come forth with a proposed $1.9 trillion spending bill while the ink is still drying on the $900b spending package passed at the end of December. Putting aside the needs and wants of more government spending, the absolute numbers are astonishing, and the debt we are fast accumulating is only accelerating.

Finally, before I get to the details, one can’t fully talk about market action in January 2021 without mentioning the extraordinary short squeezes and mania-like behavior in a select group of stocks led by GameStop. New age chat forums like Reddit have created an arena to amplify stock picks and specifically target equities with high levels of short interest positions.

Manias

I would characterize what we saw over the past few weeks in stocks such as GameStop, Koss, and AMC Entertainment as a modern day mania trip – call it Reddit Mania. This type of mania is not new. According to Charles Kindleberger in his famous book “Manias, Panics and Crashes” economic history “is replete with canal manias, railroad manias, joint stock company manias, land manias, and a host of others.” He defines ‘mania’ as “a loss of touch with reality or rationality, even something close to mass hysteria or insanity.” Thus, it is not new and only the venue of conduct and communication is different. What is also not new, and is a key underpinning, is easy money and the access to credit by the actions of the Federal Reserve.

This type of behavior is pure gambling and certainly has no place in the portfolios we create for clients. It is thus a side show, but something that bear monitoring. It may be provide sign of a broader change in risk appetite when it eventually unwinds, which as of this writing, it seems to be doing.

The Vaccine Rollout

According to the Bloomberg Vaccine Tracker, as of February 1^st, 32.8 million doses have been given in the US and we are now at a run rate of 1.34 million per day. As for the whole world, they estimate we are up to 101 million doses administered in 64 countries. Progress in being made each and every day notwithstanding the bumpy start. Hopefully, this will lead to something close to herd immunity in the US this summer which, of course, would be life changing for us personally and for those businesses most hurt by the pandemic.

Washington, DC

With barely the ink dry on the late December passage of another $900 billion of spending, the new Biden administration wants to spend another $1.9 trillion on a variety of things, some related to Covid, some not. The Republicans have countered with a plan to spend $600 billion. This will be the first test on whether we’ll see bipartisanship or not. Hopefully we will, and if so, we will likely see a spending bill of something just above $1 trillion. This would bring government spending in response to the pandemic to about $5 trillion. To quantify how large these numbers are, the US federal debt is now about $27 trillion vs the size of the US economy of $21 trillion[6]. As a percent of GDP, the budget deficit as of December was almost 16%[7]. The average over the last 50 years is 3%.[8]

Interest Rates and the US Dollar

The question always asked is, “When will all this spending and debt matter?” I believe it already has in regards to the US dollar weakness and I expect it to continue. The impact on interest rates is tougher to call. Intuitively, one would think more debt accumulation would eventually lead to higher interest rates. However, it is that higher debt level that leads to slower growth and possibly lower interest rates. Where I think it would lead to higher interest rates and higher inflation is where we are seeing too much money (thanks in part to government spending) chasing too few goods (major supply constraints).

As stated, interest rates rose in January with the 10 yr yield back above 1%. I expect rates to continue higher, and we’ll see how well the market absorbs the massive supply coming from the US Treasury to finance all these debts and deficits. This will be a key part of the inflation story with the rise in commodity prices and supply chain issues resulting in rising goods prices.

The Federal Reserve

The Federal Reserve went to the ends of the earth in 2020, as did all central banks around the world, in order to address the dramatic impact on the economy as we purposely shut things down. The Fed even did something they had never done before by purchasing US corporate bonds. In response to their actions, we’ve seen an epic rally in just about everything, even including baseball, basketball, and hockey cards. This begs the question that if all the easing was due to Covid, what happens to all this easing when Covid goes away, or is at least contained to a large extent? I believe there will be little question that the Fed and other central banks will overstay their easing welcome, and will take their time in tapering QE and in eventually raising interest rates. Thus, it could be left to the long end of the yield, aka the market, to adjust policy for them via higher rates.

So while the US economy, along with the rest of the world, should see much better economic growth numbers in the 2^nd half of 2021 as the vaccine rollout picks up steam, the markets will have to adjust to a less friendly level of interest rates and central banks that should be talking about tapering their extreme accommodation. We’ll be monitoring this closely all year.

US Economy 

With respect to the US economy, as seen in 2020, there was a clear shift in spending to goods, such as cars for those moving to the suburbs, RV’s for those wanting to vacation outdoors, on new backyards and kitchens as we spent more time at home, and on laptops, broadband and routers as our kids learned from home while we worked from home. These are not repeatable purchases like going out for dinner. The services side, such as restaurants, movies, etc… obviously bore the brunt of Covid and this shift in spending. We expect that shift to go back to services and thus, on a net basis, consumer spending might not change much. The strength in housing in 2020 should cool a bit in 2021 as a lot of pent up demand was satiated and longer term interest rates should rise. That said, Millennials are an important demographic and as they create families they will desire more space.

Conclusion

The investing world in 2021 will not be as easy as “The vaccine is here, everything will be fine!” because if there is one thing we were reminded of in 2020, the economy is not the markets and the markets’ not the economy. The vaccine will certainly lay the groundwork for a more normal return to our daily lives, both personally and professionally. Markets will also need to adjust though, particularly interest rates, and we must keep in mind what that could potentially mean for valuations. Either way, whatever the outcomes will be, it is vital that investors have a plan that suits their short term liquidity needs over the next 2-3 years. Knowing that period of time is covered can help separate the balance of one’s portfolio from what I believe will be a continued choppy time for the economy and markets. Please do not hesitate to reach out at any time with questions or for any discussion on these things.

Disclaimer