The rollout of Pfizer’s vaccine, which should be followed shortly by Moderna’s and others, is allowing the market and business leadership to focus on economic normalization as we move through 2021.
Stocks are an important indicator that give insight into future economic activity and profitability. Consequently, it is very encouraging to see stocks trading at all-time highs with cyclical stocks (that benefit greatly from the reopening of the economy) showing leadership. While significant near-term headwinds remain from the surging virus and reimplementation of lockdowns, the rollout of Pfizer’s vaccine, which should be followed shortly by Moderna’s and others, is allowing the market and business leadership to focus on economic normalization as we move through 2021.
We continue to see positive signals from many important financial assets. In addition to cyclical stocks outperforming defensives, we are seeing broad participation from individual stocks as the advance/decline (A/D) lines break to new highs (alongside prices) in the broad indexes (S&P 500, NASDAQ, Dow, Russell 2000). Corporate bonds, both investment-grade and high yield, continue to rally and suggest a lower probability of future defaults (after signaling a very high default rate this spring).
Small cap stocks have been outperforming large cap stocks, which is typically a bullish cyclical indicator. Commodity prices such as copper and oil are hitting new highs in a sign of strong future demand as economic conditions improve. Foreign stocks are also rallying in a sign of an improving global backdrop.
The 10-year Treasury yield has also been moving higher in a sign of reduced demand for safe-haven assets. The U.S. dollar continues to trend lower in another sign of reduced safe-haven demand. A weaker dollar is also beneficial to many emerging market assets as they need less of their local currency to cover their U.S. dollar-denominated debt.
Despite the virus headwind, we see a positive environment for stocks and other risk assets continuing in 2021. The Federal Reserve and other central banks remain very accommodative, which should continue to support stocks and other risk assets, while keeping financial stresses low. While there is uncertainty around the timing of the follow-on stimulus plan, consensus is forming around a $900-billion package that should ultimately bridge the hardest-hit industries until the pandemic fades with the vaccine.
The majority of leading economic indicators we focus on are suggesting we are in the early stages of a sustainable recovery. There is also significant pent-up consumer and business demand that should be unleashed with the vaccine as the pandemic fades.
While the Georgia senate race remains a short-term uncertainty risk, there is a rough balance of power that has historically been favorable for markets. The potential for lower trade tensions and tariff rollbacks would be favorable market developments should they occur under a Biden administration.
Corporate America is also holding significant levels of cash that could be used for higher investment, dividends, and share buybacks as economic conditions and corporate confidence improve with the fading of the pandemic. Improving profitability and record-low corporate bond yields are important catalysts for higher capital expenditures in 2021. Housing has been a bright spot in the recovery and we see further strength for housing in 2021, driven by pent-up demand and record-low mortgage rates.
Indeed, last week’s release of the CEO Economic Outlook Index from the Business Roundtable supported this positive outlook on corporate America, despite the current virus headwinds. This survey saw its second consecutive gain in the fourth quarter to its highest level since the second quarter of 2019. It shows growing optimism among large firm executives that the economic recovery from the pandemic will endure. CEOs expect their sales, employment, and capital expenditures to increase in 2021. In a special question, 2/3 of CEOs indicated that business conditions for their firms have already recovered or are expected to fully recover by the end of 2021.
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