Last week was my first update of the New Year and I laid out a bullish message. But I’m now a bit concerned that the market is getting ahead itself.
Equities are up across the board with banks up 7% last week on rising bond yields. Tesla shares are up 25% so far this year – the fundamentals behind that company haven’t changed at all as far as I can see. The rise probably reflects forced buying by index funds and those institutions who can’t bear the pain of their underweights – it’s now the fifth biggest stock in the US.
There are positives for the US economy
Don’t get me wrong, there’s lots of good news. Despite the fall in US employment in the figures on Friday, the economy there is doing remarkably well given the pandemic. The new President and the Democrat-controlled Congress are expected to roll out yet another fiscal package. Although there is lots of pain in the US economy, in aggregate consumers have more than enough income to spend – when the lockdown restrictions are eased. And the US vaccine roll out is proceeding apace.
The fourth quarter reporting season for earnings gets going this week, with numbers from the big US banks. I’ll be surprised if they beat expectations to anything like the degree seen in the last two quarters. And I do hope that this move to impeach President Trump doesn’t distract the incoming administration from its policy agenda, especially when it comes to the fiscal stimulus. There will be setbacks, virus mutations and so forth to worry about. But the market is prepared to look through a great deal at present, confident that the war against the virus will be won.
Markets could get the jitters about inflation
My worry is that the market will get nervous about inflation. Not in Europe or Japan, but in the US. Break-evens there have pushed above 2% at 10-year maturities for the first time since 2018. Confidence that the US Federal Reserve will keep a lid on conventional bond yields means that real yields, as measured by Inflation Protected Securities, have hit record lows. This is a great support for risk assets. But last week’s US ISM surveys – closely watched indicators – showed rising price pressures across the board. At the global level, food and other commodity prices have been rising rapidly. Base effects will come into play soon, raising year-on-year consumer prices. And there are plenty of analysts and investors who fear that all of this government debt and central bank financing will end in inflation. Don’t get me wrong, I do not expect a sustained rise in inflation, but I’m worried that the market will get nervous.
Here in the UK, the vaccine roll out is underway in earnest. Having had their fingers burned by failures over testing and PPE, the government will be keen to have success with the vaccination programme. But the pressures on the NHS are reaching breaking point, and unfortunately we still appear to be in the darkest day before the dawn.