Weekly update - 11th of January 2021
Written and accurate as at: Jan 11, 2021 Current Stats & Facts
The first week of 2021 showed no respect for the Australian summer break, producing material, market-moving developments on the macro front.
Victory in the Georgia run-off handed the Democrats control of the Senate in addition to Congress. This means more fiscal stimulus against the backdrop of already extremely accommodative monetary policy.
The current policy settings are extraordinary.
In short, we could see stimulus worth near 9% of US annual GDP channelled into the first quarters of 2021. Even if only a fraction gets spent in that period, it means both growth and earnings are likely to be a lot higher than current consensus expectations.
Initially, bonds have sold off in an orderly fashion. There has also been a rotation to value and cyclical companies in the equity market.
There are some hefty bricks in the wall of worry: perceptions of market valuation, Covid’s resurgence, lockdowns and the US political situation.
Nevertheless, the near-term crisis has forced a policy response, while the vaccine roll-out can help unleash pent-up demand. Both factors are supportive of economic growth, corporate earnings and equity markets.
The S&P/ASX 300 has gained 2.59% for the year, while the S&P 500 is up 1.88%.
US policy: near term
The Georgia Senate run-off's key implication is the promise of additional stimulus the Democrats promised to get over the line.
Congress had already passed a stimulus bill worth US$900 billion, or 4 per cent of GDP. Some US$100 billion has already been sent out. Another US$150 billion is due in January and the same again in February.
Now there is the expectation of two or three additional packages.
First could be a Q1 package estimated at US$900 million to US$1.5 trillion – potentially worth another 5 per cent or so of GDP.
This includes measures such as the top-up of stimulus cheques from US$600 to US$2,000 – effectively promised in the Georgian campaign. This could be structured as part of a broader package – or as a stand-alone bill for swifter implementation – and would be a US$450 million economic sugar hit.
There could also be additional measures targeted at extending the unemployment insurance (UI) support, propping up state and municipal governments, helping small business and funding vaccination programs.
Passage of a broad package through Congress could take place in late February or early March. March 13 is seen as something of a cut-off – this is when the current UI payments expire.
The second package of US$1 trillion in infrastructure-relating spending is mooted for the second quarter.
The simple conclusion is that the economy is likely to see a huge injection of stimulus in the near term. This is likely to translate to far higher corporate earnings than many currently expect.
US policy: longer-term
We don’t believe the win in Georgia necessarily leads to the legislation of some of the more radical Democrat policies, given their majority remains thin in both Houses.
The market’s concerns are centred on the potential for tax increases. Corporate tax rates are likely to increase from 21% to something in the vicinity of 23-25%, rather than the 28% pledged by Biden on the campaign trail.
There may be some incremental increases and changes in criteria for capital gains tax. However, the Democrat wish-list in terms of the minimum wage, tech regulation, environmental regulation and infrastructure would all need bipartisan support for passage.
It is important to remember the Fed’s conceptual shift from expected to actual inflation targeting and its stated desire to see inflation run above 2% for a sustained period. This is likely to require unemployment to drop below 3%, which will take some time.
To give some context to this shift, the Fed indicated that the rise in rates post-GFC would have been delayed around two and three-quarter years under the current policy framework.
Fed balance sheet expansion is also unlikely to begin tapering soon – not until unemployment falls below 5%, expected in early 2022.
The combination of this fiscal stimulus and Fed accommodation means the US economy could grow above 6% through 2021, driving earnings upgrades and supporting valuations.
US economy: current state
Movement restrictions in response to the Covid surge weighed on the most recent employment data.
December non-farm payrolls fell 140,000 versus an expected increase of 50,000. That said, the net revision to the previous month was +135,000.
Nevertheless, the pressure on the leisure and hospitality sector is clear, with non-farm payrolls down 498,000.
This does not necessarily imply a poor Q4 GDP outcome: the re-build of inventories and net exports improvement could still drive 5-8% growth.
But the upshot is that the strong bounce in payrolls from Q2 last year is stalling at 9.8 million jobs below the level of February 2020.
This reinforces the need for both sustained fiscal policy and monetary accommodation. In 2001 it took four years to return to the previous peak in payrolls – and it took six years from 2008.
Even if the post-pandemic recovery is robust, we are still likely to see two to three years of accommodative policy.
Real-time and survey data indicates the US consumer was a touch weaker through the holiday period (about -1%), but on balance probably held up better than many expected.
It is worth noting the shift to online spending persists. It was 23.4% of total spending in December, versus 21.2% in November.
Corporate survey data still looks ok. The Evercore ISI survey continues to recover and is at pre-Covid levels. The underlying recovery in ISM data indicates the potential for corporate earnings recovery.
COVID and vaccines
The number of cases has continued to worsen globally. Mortality rates have returned to peak levels in several countries, and there is a substantial strain on healthcare systems.
The focus remains on vaccines.
The roll-out has been delayed in most countries, but the ramp appears to be occurring in terms of percentage of population vaccinated.
Trial data is due soon from Johnson & Johnson, which is important given it is a single dose trial and the company has sizeable orders. There is also the potential for Novavax to provide an update soon, which is important given Australia's orders.
At this point, initial evidence suggests vaccinations are effective against the emerging mutations, and experts are confident this remains the case. Nevertheless, this remains a risk to watch.
Markets
The key issue has been the sell-off in bond markets since Georgia.
This has remained orderly and appears to be driven more by inflation expectations than real rates, which is important for asset prices. The yield curve has continued to steepen, which is positive for cyclical stocks in the equity market.
Some rotation accompanied this to value in equities – although perhaps more muted than expected, with half of it given back towards the end of last week.
The announcement that Saudi Arabia would take the lead in constraining oil supply until demand recovers are significant. Brent crude is up 8.1% YTD, and the energy sector has benefited from both this and the general rotation in equities. From here, oil can serve both as a play of inflation and on vaccines.
The key drag on demand remains aviation – while a successful vaccine roll-out could see a rapid recovery in air travel.
Spot LNG markets are also strong for the first time in a while, which is good news for Australian energy companies.
The macro-environment has driven most stock action on the ASX.
Energy stocks Oil Search (OSH, +15.1%), Santos (STO, +11.3%) and Woodside (WPL, +9.1%) have been among the market’s best. Cyclicals OZ Minerals (OZL, +11.3%), BHP (BHP, +10.0%), Rio Tinto (RIO, +8.9%) and Fortescue (FMG, +8.2%) have also been strong.
A private equity bidder for Link (LNK) withdrew, knocking 16.2% off the share price.
Otherwise, most of the underperformers have been defensives or growth stocks.