The S&P 500 posted its largest-ever gain from election day through inauguration day, but cracks have begun to emerge in the rally. The past week has been marked by a broad deterioration in market momentum. With the S&P 500 down roughly 3.7% on the week, we may be in the early innings of a correction. This is consistent with historical seasonal returns in the first year of a new President and could be expected given the stretched market sentiment of late. It is important to note, however, that the deterioration is not particularly sinister given the positive long-term trend and the strength of underlying credit conditions. Rather, we would characterize a pullback as normal and healthy.
In a wild week, where retail speculation in heavily shorted stocks was front and center, the Fed received little attention. However, there were some noteworthy developments in this month's release and press conference. Chairman Powell was questioned on the course of Fed policy with inflation expectations on the rise. He remained steadfast in the committee's stance that runaway inflation is a low and far away probability. Instead, he sought to shift the focus back towards finishing the recovery effort and noted that the Fed is committed to doing whatever it takes to see the economy through the COVID-19 crisis. Rate hikes are off the table even if inflation numbers rise on a year over year basis when compared to last year's lows. Any such rise in inflation would generally be viewed by the committee as transitory. They remain more concerned with the deflationary secular forces at work and continue to target sustained inflation above 2%.
For the market, this means that there is a low probability of the Fed breaking up the party anytime soon. It is clear that policy will remain accommodative, which should be supportive for financial markets. This continues to lend confidence to our bullish view for the long-term trajectory of the market. We don't know exactly when Covid will end, but we know that it will. When it does, there will be a lot more cash in the economy than there was when it started. Because of this, we are inclined to view any pullback over the next few months opportunistically.
On the earnings front, companies have continued to beat to the upside and raise forward guidance. Yet, they have not been rewarded with price gains thus far. The "sausage-making" narrative appears to have taken over. It is more important for the market to see progress in Congress and progress in administering the vaccine than it is to see what companies are saying. Without those two things, company guidance is speculation. Nonetheless, we believe these issues will resolve in time, and markets will continue their drift higher.
Preston May, CBE®
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