Inflation is steady on the surface, volatile underneath
Inflation expectations have been a topic of growing interest thanks to the extraordinary fiscal and monetary support in place for much of the last year, most recently the huge $1.9 trillion American Rescue Plan that is currently sending checks out to millions of Americans.
All of this new spending by the federal government, along with the economic recovery permitted by the rollout of COVID-19 vaccines, is provoking more discussion about whether demand for goods and services will outpace the economy’s ability to produce them and push prices higher.
S&P 500 earnings have fully recovered, but with wide differences among sectors
The S&P 500 has reported another strong earnings season for Q4, with 79% of companies beating consensus earnings estimates for the quarter. This would be the third highest such reading in Factset’s data since 2008. The beat rate for top-line sales was similarly high at 77%. Aggregate income for the index is about 4% above year-ago levels, indicating that net income on a quarterly basis has fully recovered pre-COVID levels based on Factset’s data.
Reviewing current stock vs bond sentiment
Despite what you might hear or read some places, investor surveys do not show an extreme level of optimism toward US stocks. Bullishness on stocks has in fact declined somewhat recently and is not far from long-term average readings.
Sentiment toward bonds, by contrast, has moved quite sharply and is now approaching extreme bearishness by the standards of recent years. This is not too surprising, given that long-term Treasury bond yields have recently risen to their highest levels since COVID hit early last year. The result has been that investors in long-term (20+ year) Treasury bonds have lost about 13% since the end of November and about 18% since the end of July.
Bond market making some noise
The bond market has clearly awoken from what appeared to be a low-volatility Fed-induced slumber for much of last year. Longer-term bond yields in the US and elsewhere have jumped to their highest levels since just before the COVID crisis hit markets early last year (blue line in first chart below). Even after this rise, though, the 10-year Treasury yield remains below even the low points of previous cycles.
Recent rally in “junk stocks” is not unusual
Financial headlines have been captivated recently by explosive behavior in certain “meme stocks” that have been the subject of intense speculation by online retail traders as well as some hedge funds. This has been accompanied by a general trend of outperformance by smaller, money-losing, heavily-shorted, and volatile stocks (sometimes referred to as “junk stocks”, similar to risky high-yield “junk bonds”).
Semis vs Software trade now favors Semis
Within the broad Technology sector, there are often significant divergences among the various industries. A key intra-sector industry relationship that many investors use as a touchstone is the relative performance of Semiconductors versus Software.
These two industries capture different parts of the Technology ecosystem. Due to their widespread use in so many devices and products, the Semiconductors and Semiconductor Equipment industry reflects demand for hardware, both within Technology (servers, PCs, phones) and in other sectors (e.g. autos), and thus tends to be much more cyclical. Software tends to be much more stable, with more recurring revenue, and nowadays is closer to a service-type industry. There is much less chance of major “shortages” or “oversupply” of software of the kind that semiconductor makers must often deal with.
US earnings estimate revisions trends remain strong amid Q4 earnings season
While certain heavily shorted stocks are getting much of the attention lately due to retail-driven price surges, the bigger picture news is Q4 earnings reports and analyst behavior.
We track earnings estimates for a broad universe of about 2300 US stocks (market cap of $200 million and up) and construct estimate revisions indicators using two key metrics: breadth and magnitude. Breadth is the net proportion of analysts raising versus lowering estimates for a stock, which is -100% if all analysts are cutting their earnings estimates and +100% if all are raising estimates (0 indicates a balance between positive and negative revisions, or no activity at all). We look at this proportion based on revisions that occurred over the last 100 calendar days (about one quarterly reporting cycle).
Still a risk-on environment, but option traders remain nervous
Markets globally continue to show strong risk-seeking behavior, a continuation of the broader trend in place for much of the time since late March 2020. That was the point at which monetary and fiscal policy activity surged to produce enormous stimulus in the US and globally.
Recent US legislation that included a total of about $900 billion in new fiscal support is now starting to be felt, and recent political developments have increased the odds of further fiscal support this year. Alongside this persistent fiscal support to counteract the severe economic impacts of COVID-19, monetary policy remains extremely accommodative. Near-zero policy rates and heavy bond buying programs are expected to be maintained for many months if not years, putting both monetary and fiscal policy firmly in the “highly stimulative” category at the same time.
Inflation likely to remain moderate even with more fiscal support
The news of Joe Biden winning the US presidency in November has now been joined by news that the US Senate will very likely be under the most narrow control of the Democratic party, along with a narrow majority in the House of Representatives. These developments have led investors to expect more fiscal stimulus and other support than would have been expected under continued Republican control of the Executive branch and Senate.
“K”-shaped economy clearly visible in the labor market
The US labor market is showing mixed signals depending on the data and time period used. Here we review some data that can help identify the divergences and put current conditions in context.
There has been much discussion about the “K-shaped” recovery in the economy following the shock of the initial lockdowns in the second quarter of this year. The “K” is meant to represent a sharp divergence between industries and workers who have been unaffected by or benefited from recent conditions (the top of the “K”), and those who have been hurt (the bottom of the “K”).