It was a quiet week for the equity market, with the S&P 500 finishing around .7% lower from last Friday's high. Treasury bonds were a different story. The selloff in 10-year treasuries continued with yields closing at 1.35% on the week. The 10-year yield has moved to the doorstep of its pre-pandemic level, with the market continuing to price in reflation. The country appears to be turning the corner on the virus just as Congress prepares to vote on stimulus 3.0. If January's retail sales are an indication, the previous stimulus package has left consumers flush with cash and ready to spend. Once the virus is contained, there should be significant pent-up demand. The move in yields reflects this.
Congress is getting just enough poor economic data to push forward with their 3rd go at stimulus. The labor market has been stubbornly slow to recover despite an unemployment rate that would suggest otherwise. A significant number of Americans have left the labor force entirely, which has artificially lowered the unemployment rate. Jobless claims also continue to disappoint. This has given Democrats cover to go big on more stimulus. We are looking at adding an extra $1.4 to $1.9 Trillion on top of the already unprecedented first two rounds. With the Senate's margin so tight, Democrats are using this budget reconciliation process to advance their policy agenda. Within stimulus 3.0, there are expected to be provisions to expand the Affordable Care Act significantly. However, the window is closing with reopening on the horizon.
Because of the move in yields, we see a reaction from the equity market's interest rate-sensitive sectors. Staples, REITs, and Utilities have been underperforming. Banks and Industrials have been outperforming. Over the last few months, we have shifted our portfolios to better align with reflation and higher rates. We believe that the move higher in yields could have room to run. There is resistance around current levels, but beyond that, the next stop is around 2%.
The performance of the equity market over the next year is likely going to depend on the pace of the rise in yields. The market can digest a gradual rise in yields to 2%. A move to 2% over a week or a month would be a problem. Such a move would signal that the economy is on the path to overheating. Right now, the Fed is far more concerned about the recovery falling short vs. an economy running too hot. Still, a quick rise in yields could force the committee's language to change and the equity market to take notice. We continue to have our eyes on yields and key inflation metrics.
Preston May, CBE®
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