As of April 20, 2021
- Stock prices continue to hit new highs.
- A strengthening job market and the expectation of accelerating corporate profits favor a bullish view.
- Temporary inflation pressures are not likely to change the Fed’s easy money policies.
Stock prices began the second quarter similar to first quarter — hitting new highs.
Since 2012, the S&P 500® Index hasn’t produced a negative return in April. Based on performance this month — 7 of the 11 sectors posted new intraday highs. Thus far, U.S. stocks look to keep the streak alive. Notably, large-cap growth stocks have seen renewed buying interest, driven by solid gains across the Information Technology and Consumer Discretionary sectors. The NASDAQ Composite also has steadily climbed higher this month.
At the same time, the 10-Year U.S. Treasury yield has moderated lower. In our view, rates are walking back some of their Q1 surge higher and, as a result, tech stocks are benefiting. At the moment, investors seem busy triangulating the intersection between easy monetary policies, the odds those easy conditions will remain in place this year and the prospects for rising inflation pressures. As we noted last month, we expect inflation pressures to increase through the summer and moderate lower as the year comes to a close.
Bottom line: The moderation in longer-term rates suggests investors are growing more comfortable with a higher equilibrium level and have more confidence that Fed policy will remain accommodative through 2021. As a result, high-growth stocks in the Information Technology and Consumer Discretionary sectors are seeing continued robust performance at the start of Q2.
The Federal Reserve remains accommodative
We believe the central bank is committed to extraordinary accommodation. This is based on the Fed’s consistent messaging of outcome-based policies: price stability (i.e., purchasing power) and maximum employment.
This means the Fed is very unlikely this year to taper its $120-billion-a-month bond asset purchase program, let alone raise interest rates. Even in the face of temporary inflation pressures and potentially million-plus new job growth over multiple months, the Fed has the market's back, in our view.
We believe the first step in any tightening strategy would be to communicate the intention to taper asset purchases. Here, it is also unlikely until late this year or early next year the Fed would even hint at such a strategy, in our view. For investors, the extraordinary monetary accommodation currently in place should remain a supportive tailwind for asset prices. However, stock prices may ebb and flow over the near term during periods of uncertainty.
Employment conditions are improving
In March, the United States gained +916,000 new jobs — the largest monthly increase since August 2020 — and the unemployment rate fell to 6.0% from 6.2% in February. This is consistent with ongoing manufacturing strength, higher mobility trends and stronger consumer confidence.
The building momentum across the U.S. economy has come from the services sectors, as industries and areas tied to reopenings have accelerated business activity. In our view, this momentum is resulting in job creation. For example, the leisure/hospitality industry created +280,000 new jobs in March. This more robust job growth has helped restaurants, hotels and other related industries meet growing customer demand.
In our view, employment trends should continue to accelerate in areas previously depressed by COVID-19 and state restrictions. Simply, more job growth equals better overall economic conditions. Over a number of months, it would not be unreasonable to see monthly growth near or above 1 million new jobs.
While great for the economy, at some point the stock market may see a stronger job market as a cue for tighter monetary policy. But again, we believe it’s unlikely the Federal Reserve will withdraw its accommodation this year.
Yet, stocks discount the future six to 12 months out. Several months of seven-figure job gains could cause investors to start seeing “good” incoming economic data as “not-so-good” data for future stock prices. Again, although not an immediate threat to asset prices, it is worth watching over the next quarter or two. Balancing current stock prices against outsized growth trends in the economy is likely to become more challenging as the year progresses.
However, key to supporting current stock levels is the assumption that first quarter corporate earnings grew year over year by roughly +25% — the fastest pace since the third quarter of 2018. As the earnings season begins this month, investors expect a strong showing from U.S. companies. There is a historical precedent for companies to outshine analysts’ profit estimates, and we believe analysts have remained conservative in their forecasts.
In our view, stocks could react positively to a equilibrium in interest rates, improved reopening trends and strong first quarter earnings. Altogether, this could provide favorable tailwinds for stock prices. That said, an unexpected surge in interest rates and inflation pressure could cause near-term indigestion for equities, particularly for growth stocks.
In part, company-specific dynamics and individual business trends could significantly influence the market's day-to-day movements over the coming weeks of the reporting season. And that’s just fine in our book. Investors have a good understanding of the reopening theme and how it should affect asset prices. Company updates on the first quarter — and perspective on what lies ahead — should add new understanding of the recovery’s underlying strength as the second quarter progresses.
Data source for indices and sector graphs: Morningstar Direct, as of April 12, 2021.
Past performance is not a guarantee of future results.