February marked an acceleration of investor optimism for a strengthening economy. Amidst the backdrop of falling COVID cases, vaccination progress, and House passage of a $1.9 Trillion stimulus bill, the S&P 500 index rose 2.6% for the month. Cyclical sectors like energy, financials, and industrials led the market. Perhaps more encouraging for the economy, is strength outside of the stock market. 10 Year treasury yields rose as the yield curve steepened – a sign of bond market expectations for stronger growth. In the commodities markets, economically sensitive metals like copper (+16%) and aluminum (+11%) rallied, while Brent Crude climbed 18%. Consumers continue to shift spending towards goods at the expense of services (restaurants, hotels), leading manufacturing back to pre-COVID output levels.
The housing market continues to be a point of strength for the economy as residential construction spending reached all-time highs, spurred by record-low inventories. New building permits reached a 15-year high, signaling continued strength. Mortgage rates have remained low, despite the rising long term treasury yields. Below is a US housing market chart with new homebuilding permits and housing starts on the left axis and prices on the right.
With the positive economic signals, a new dynamic is emerging for markets. Will the latest round of stimulus amidst a reopening economy create inflation for the first time since the 2000s? Labor market “slack” – excess job seekers – should provide some cushion against inflation in the near term. Supply chains (eventually) stabilizing following COVID-related disruptions and shifts in consumer demand should also provide a ballast. Higher inflation would also drive bond yields higher. Higher bond yields have historically resulted in lower valuations for stocks, as it creates a higher opportunity cost for stocks relative to bonds. It is likely those stocks with the most “stretched” valuations and least to gain from inflation are most at risk of a continued rise in bond yields. Some will stand to benefit.
-Jared J. Ruxer, MS