In this week’s market update: risk appetite returns as investors focus on big US stimulus; earnings season picks up on the positive market mood; and meanwhile the speculative GameStop froth appears to blow away for now.
Stock markets are hitting new all-time highs, and flows into investment funds are running at historically high levels, as a consensus builds that the second half of 2021 will see a positive mix of stimulus, liquidity, the unleashing of post-pandemic demand and a widespread re-opening of the economy on the back of widespread vaccinations.
This week should see a down-payment on that bullish scenario via Joe Biden’s proposed $1.9trn fiscal stimulus package which the narrow Democrat majority in the Senate should enable despite concerns from some quarters that it pours fuel on an already smouldering economic fire. The latest spending proposals bring the total spend since the pandemic to around $5trn, or 25% of GDP, in the US alone sparking renewed inflation hopes or fears, depending on how fast prices start to rise.
Markets are already voting with their feet on the stimulus story, with the S&P 500 edging ever closer to the 4,000 hurdle. At 3,915 at Monday’s close, the US benchmark has risen by 18% year on year, which is scarcely believable when you consider what has happened in the 12 months since last February. Even here in the much more out of favour UK market, shares are also around 18% higher than they were at the start of November three months ago, albeit still below their level of a year ago. In Japan the Topix index closed at its highest level for 30 years, soon after the peak of the Japanese property and shares boom of the late 1980s.
The key driver of the market rally is, of course, the co-ordinated government and central bank response which is unprecedented and massively bigger than the more tentative support operation in response to the financial crisis 12 years ago. Then, as the economic output gap narrowed, policy tightened but this time around there is no sign of that happening. The authorities seem determined to let the economy run hot to ensure the recovery is firmly entrenched as we emerge from the pandemic.
We are starting to see this show up in a range of measures. As ever, the good news was reflected first in the stock market which anticipates positive developments long before they appear in the real-world data. So, valuation multiples have risen, but not yet to levels at which a correction seems imminent.
Other important signals of growth to come include bond yields where long yields, which move on growth and inflation expectations, are rising more quickly than those at the short end of the curve, which are more influenced by the level of interest rates. This rising yield curve is generally seen as a signal of better times tomorrow coming as a result of easy monetary policy today.
At the corporate coal-face, too, we are seeing positive signs. The fourth quarter earnings season, which is in full swing at the moment, around half of S&P 500 companies have now reported, with 80% of them beating expectations by an average of just under 20%. The early expectations of a 9% fall in earnings year on year now looks like a 4% rise on average. This is a key part of the case for equities. Earnings were always going to have to arrive to justify higher valuations and it looks like they finally are.
One other asset which tends to be a good indicator of economic strength is the oil price. And here, too, the signs are good. Oil has risen above $60 a barrel for the first time since February last year as expectations for the release of pent-up demand for consumption and travel hits up against restricted output from producers like Saudi Arabia.
And it is not just oil that is rising in the commodities world. Prices are rising across the board as investors decide that the next long upswing, or supercycle, may be underway. Commodities have been out of favour ever since the financial crisis as sluggish growth put a lid on demand for industrial metals. But that in turn led to a lack of investment in new supply. A lack of supply and an expected rise in demand is having the predicted impact on prices.
Copper, for example, often seen as a bellwether for commodities generally, is up 40% over the past year. A basket of 27 commodities has seen rises in every single asset over the six months to January. This is the first time in 50 years that this broad-based rally has occurred.
Another indicator of rising economic optimism is the relative performance of more cyclical, value focused parts of the stock market like smaller companies compared to the more defensive big-cap end which holds up better during a downturn. The ratio of the Russell 2000 small cap index to the S&P 500 has been rising throughout the pandemic and turned sharply higher at the end of last year as the prospect of a reflationary stimulus package came into view.
There’s a similar story with the relationship between the US market and those in the emerging world where the long-standing outperformance by the defensive US market has reversed, partly a reflection of a weakening US dollar, which favours emerging markets.
The tail-winds behind emerging markets, and China in particular, are particularly in evidence this week as some businesses in China are encouraging people to keep working through the traditional week long New Year holiday in order to meet booming demand for Chinese goods around the world. The final signal of good news to come is the relatively poor performance of safe haven assets like gold, which has fallen from a recent high of $2,075 an ounce to under $1,800 an ounce today. Gold does well when real, inflation-adjusted bond yields are negative because then there is little reason not to hold an asset which pays no income. Real bond yields are holding steady now because inflation expectations are rising at roughly the same pace as nominal bond yields.
Meanwhile, the story which grabbed all the headlines just a week or so ago, the GameStop saga, seems to have fallen out of the headlines as quickly as it hit them. Fears that excessive speculative behaviour from co-ordinated groups of retail investors might mark the top of the cycle have faded as sharply falling prices of the most popular trades have dampened the enthusiasm of inexperienced investors looking for a quick and easy way to make money.
GameStop, which peaked at nearly $500 a share was by the end of last week trading at safely under $100 so many of the investors gathered on Reddit discussions boards like WallStreetBets and trading on free-dealing sites like Robinhood have retreated to reconsider their approach.
Speculative excess is a good sign of the top of the market but not necessarily the signal of an imminent peak. Back in the dot.com bubble markets continued to rise for at least a year after similar examples of erratic behaviour and the top of the market was anyway more a result of a tightening in monetary policy than just investor excess.
On the economic front, the main focus will be on inflation data this week. On Wednesday both China and the US update on consumer prices. Here in the UK, the highlight is Friday’s fourth quarter GDP data which should show a slowing in the rate of recovery thanks to the November lockdown but hopefully not a decline in growth which would combine with a likely fall in the first quarter of this year to deliver a technical recession. The fall in the first three months of this year look unavoidable due to the third national lockdown but is likely to be much more subdued than last year’s spring downturn as we have adapted to life under stay at home rules.
And in the ‘and finally’ slot this week, the unexpected story is that of Tesla buying $1.5bn worth of bitcoin last month. Although this represents less than a tenth of Tesla’s cash balances and less than 1% of its market capitalisation, it is a curious move and, as with most things Elon Musk related, it is hard to know what the real motivation is. What is for certain, the news of the purchase sent the price of bitcoin up 10% to a new record high of $44,100.