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Weekly market update - 22nd of March 2021

Written and accurate as at: Mar 22, 2021 Current Stats & Facts

Two concerns emerged last week. Both bear close watching.

First was the emergence of another wave of Covid cases in Europe. The pace of vaccination has been too slow, and Covid variants have taken hold, driving an increase in new daily cases across the EU. There are some emerging signs that the early removal of restrictions in the US may see growth in new cases in some states.

The second issue is growing scepticism over the Fed’s ability to keep rates low for an extended period, despite its reiterated stance. The risk here is of a sharp bond sell-off which contaminates equities.

At this point, global equities continue to hold up well. But we note the oil price fell 7% last week. There is a risk this is the first sign of this year’s winning trades rolling over.

On the positive side, earnings continue to support markets. The US economy is taking off, while the Australian economy is doing better than expected — as evidenced by last week’s employment data. This can help sustain equities through a consolidation phase while the market adjusts to higher bond yields.

The S&P/ASX 300 fell 0.8% last week, while the S&P 500 was off 0.7%.

Covid and Vaccines

Overall, new daily cases in the US continue to fall, but states such as Michigan and Florida have turned higher. The arrival of Spring and the removal of restrictions is expected to lead to a new wave in cases. The issue is how material this will become given the level of vaccines and high levels of prior infection. Very high vaccination rates among the more vulnerable parts of society may mean far less pressure on hospitals. 

Europe is more of a concern, and a significant new wave is possible. There are renewed lockdowns in Poland and France. Non-essential businesses in Paris have been closed. Growth in concerns is likely to have played a part in a weaker oil price over the week.  

Economic and policy

The market’s essential paradox is that two-year inflation expectations in the US are nearing 3% — beyond the Fed’s 2% target — but the Fed’s guidance is for continued loose policy. The market is increasingly uncomfortable with this notion.

The Fed meeting this week reinforced this paradox with a message of more of the same. It re-affirmed a dovish perspective, with the majority of the FOMC seeing no rate hikes in CY22 and 23. The rationale is they expect strong near-term growth to fade, easing inflationary pressures. Their expectation is 2% inflation for CY22 and only marginally higher in CY 23.

The Fed appears to be comfortable with bonds finding a new long-term equilibrium and do not want to get in the way of it. The Bank of England also met this week and indicated comfort in rising bond yields.

The risk is that this process is not smooth. The sale of bonds becomes disorderly, given the unprecedented coincidence of strong pent-up demand-driven recovery, fiscal stimulus and loose monetary policy.

The markets can see the disconnection in expectations in the large spread between the Fed’s guidance and the market expectation of hikes implied in overnight index swaps (OIS). By the time the first rate hike is officially expected in Q4 2023, the market-implied expectations are for three 25bp rate hikes — the first coming in early 2023.

The paradox can also see within the FOMC itself. Five members expect three-to-four rate hikes by the end of CY23 — i.e. believing what the market is saying — while 11 see no such increases. The fact that this dichotomy exists even within the Fed suggests the market’s current expectation is plausible.

Economist and former US Treasury Secretary Larry Summers provided an interesting perspective last week. He repeated his observation that the US was plugging a 3-4% gap in GDP with 14% worth of stimulus. He also noted a contradiction in the narrative that this is a new paradigm for progressive policies which will deal with structural challenges such as inequality and addressing climate change – but that the effects of the fiscal stimulus are transitory and will fade in CY22, meaning inflation is not an issue.

The key to this is how well inflation expectations are anchored. The Fed believes they are well anchored. The risk is that this belief is undermined, and they are forced to re-anchor through a policy pivot.

This will be the key debate for the next six months. It could make for some choppy moments and heightened sensitivity to near-term signals. The strength of the recovery in the US economy will be the key issue to watch.

We note that the basing out of the US dollar index may help manage inflation expectations. There are a lot of sectors correlated with the USD, notably resources. Recent USD strengthening partly explains the sell-off in resources stocks and remains an important factor to follow. 

On the US fiscal side, the focus is shifting to the tax increase, which will come as part of the infrastructure bill. The Bill itself is still expected to be about US$2 trillion, with half towards hard infrastructure and the remainder to healthcare, education and research and development.

Half the funding is intended to be from net tax increases, including 28% corporate tax. There will be a lot of disagreement over tax rates within Congress, which may impede progress. But the headlines are likely to add to the market concern. One potential resolution may see the Bill broken up into a bi-partisan infrastructure Bill and then a second one that is more progressive and partisan, incorporating tax increases.

We also got important Australian data last week. Employment data was robust. The unemployment rate fell to 5.8% — 0.5% below expectations. This supports the view that any set-back from the end of JobKeeper will be limited and short-lived, as long as no more lockdowns occur. The employment / population ratio is 62.3%, versus 62.7% pre-Covid. The unemployment rate remains a little higher due to participation rates actually rising. Nevertheless, Australia has effectively recovered all jobs and is well ahead of other countries in this regard.

Retail sales data was more subdued following a solid run. It is a reminder that it is vulnerable to normalisation as opportunities emerge to direct spending to other areas such as domestic travel. The softness was more in food sales, indicating people may be beginning to eat out of the home more often.

We also had population growth data for the end of September, which, unsurprisingly, has slowed dramatically. This will eventually begin to cause issues for economic growth and housing demand. But for now, it will perhaps allow the unemployment rate to fall further and quicker than expected. We expect immigration will be high on the government’s agenda – and that the last 12 months have probably increased Australia’s attraction to potential migrants.


Equities continue to be resilient in the face of the bond sell-off. 10-year government bonds are on track for their worst quarter for returns in 50 years. Despite this, equities in the US are up 4.5%, helped by strength in corporate earnings.

The Australian market fell last week, mainly due to resources stocks falling in sympathy with commodity prices. There was a rotation to more defensive names. Over the calendar, year to date resources are now underperforming. Banks are the clear lead sector, while tech is the worst.

We saw some of the more speculative tech names affected, which is understandable given the rise in bond yields.

The market was led by stocks that had lagged more recently. Some of the US dollar-sensitive stocks did well. Retailers also recovered, as did gold miners.

There was some news flow on key positions in the portfolios.

Metcash (MTS, -2.5%) delivered a constructive strategy day. The IGA franchise has won market share due to changing shopping habits to more regional and neighbourhood centres. They have now moved back into store expansion, rather than closures, while Aldi’s roll-out has ended. This suggests they can maintain a presence in this space.  The company upped its payout ratio from 60% to 70%, which can be funded despite the CAPEX and means the yield is running at 5%.

Gold miner Evolution (EVN, +5.1%) announced a mid-sized debt-funded acquisition of a Canadian gold company adjacent to their existing Red Lake mine. This and allows them to bring forward production and reduce CAPEX, so it was well received.

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