Q1 2021 Market Update

The New Year is being greeted with major stock market averages jumping to new record highs. The Global economy has emerged from its 2020 recession into an expansion fueled by a record amount of global monetary stimulus never seen before. Congress provided $2T in assistance to the unemployed and small businesses in March, and another $900b package in December was added. The Fed lowered the funds rate to zero. The prospects of additional fiscal stimulus in the neighborhood of $1-$2T improved with Democrats winning both runoff elections in Georgia to secure a slim Senate majority.

Democratic control of Senate should result in additional stimulus, including the expansion of payments to individuals. In general, households and businesses are in good shape with latent spending power. The savings rate is 13% way above normal 5%. Consumer debt services payments are at decade lows. Furthermore, credit scores are at record highs! Nationwide shutdowns are the only thing holding back a spending boom. A strong re-opening unleashing pent up demand will also lower unemployment thereby boosting incomes.

Given the number of moderate Democratic Senators it is unlikely that the Senate flipping control will result in an aggressive change in the status quo that might involve court-packing; even the end of the filibuster is relatively unlikely. That said, more friendly fiscal policy should be good for corporate bottom lines. However, risks to profitability from a stronger regulatory agenda and higher corporate tax rates are material offsets. Biden tax proposals would lower corporate profits by an estimated ten percent annual rate.

2021 consensus corporate earnings of $167 likely to be too conservative. I expect earnings to surprise to the upside reaching as high as $178 due to factors mentioned. I think the 10-Year Treasury yield could reach 1.5% sometime this year from its current level of 1.1%. The cost of capital would still be below historical averages for the kind of economic growth forecasted. Cheaper cost of capital would allow stocks to trade at higher valuations and provide decent returns. Altogether, the S&P 500 Index could advance from current levels by mid-single digit percent in 2021. A few other equity sectors could outperform the S&P 500 Index such as foreign securities.

The stock market enters 2021 in a cyclical bull market, but risks increase in the second half could cap its advance. The top risks are rising yields, and higher corporate and income taxation. Higher yields would cause market valuations to compress, and higher taxation would hurt corporate profits. I expect a pullback at some point in coming months. It is a dip buying opportunity. There is no recession in foreseeable future. Instead, faster economic growth lies ahead, and modest inflation. Stocks thrive in an environment of faster growth, modest inflation, and a low-rate environment. Unemployment should remain high enough for the Fed to be on hold in 2021 and let inflation run hot. Stocks outperform cash, but cash outperforms Treasury bonds at least for the first half of 2021.