The story of the first quarter was really one of mobilization and execution, particularly with regard to vaccination rollouts. What started as a seemingly aggressive goal set by the Biden Administration proved to be a surprisingly low bar. American ingenuity is again showing its ability to tackle a monumental challenge and is on pace to double or triple the number of administered doses set forth in the original goal. That’s good news for the economy and for investors. Cyclical stocks have outperformed last year’s technology winners so far in 2021 as investors position for GDP growth forecasts not seen since 1984. The Dow and S&P 500 have outpaced the NASDAQ year-to-date – highlighting this rotation towards economically sensitive sectors.
Bond investors, sensing a fast-tracking reopening, have sold bonds, pushing yields up sharply. The benchmark 10-Year Treasury yield, which bottomed at 0.52% in August, increased from 0.93% in January to 1.73% at the end of March. In absolute terms, rates are still very low, but that’s a rather dramatic tripling of the yield on the 10-Year in a short period. It might be reasonably expected that rates work their way higher as the economy gains momentum. However, with German and Japanese government bond yields still negative, there may be a natural governor on the pace of rising rates in the U.S. At the margin, higher rates will be a headwind for stock valuations (particularly the high-flying growth stocks), but to the extent the economy is in high gear, stronger profits should offset some valuation pressure from rates.
If the early stages of vaccination efforts and “the reopening” are any indication, Americans are enthusiastic about getting back to what we do – traveling, socializing, and spending money. Daily TSA checkpoint screenings were solidly above one million passengers for 21 straight days to end March. Restaurants are scrambling to hire employees to meet returning patrons, and forecasters see a return to full employment as early as this time next year.
With interest rates still low, massive liquidity sloshing around in the system, and consumers and businesses looking to spend and invest, you can see why economic forecasts are bright. The risk of course is that the massive stimulus measures will create inflation as the slack is wrung from the system. At this point it feels like bonds and stocks are appropriately positioning for accelerating growth, not runaway inflation. Nonetheless, the longer-term impact of multiple unprecedented liquidity injections is a risk worth considering. If rates rise too rapidly (what the Fed might consider a “disorderly manner”) or if profits disappoint, stocks will likely struggle.