The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“You were given the choice between war and dishonour. You chose dishonour and you will have war.” – Winston Churchill
Don’t count your Senators before they hatch
Democrats might not be riding an actual Blue Wave, but they’ll nevertheless have slim majorities in both houses of Congress after Jon Ossoff and Raphael Warnock won their respective Senate runoff elections in Georgia last week. (Actually, the Senate is split 50/50. But assuming members vote along party lines, Vice President Kamala Harris would cast the deciding vote in the event of a tie.)
Most importantly, this means Democrats will control the floor and the committees in the Senate, making it more likely that a greater number of measures that pass the House will at least get a hearing in the upper chamber. Americans might not see the passage of some of the more progressive reform legislation in areas like climate change or health care, but there are a few bills likely to make it to President Biden’s desk this year:
- An increase in the amount of the relief checks that were part of the recently passed fiscal stimulus, from $600 to $2,000 (subject to higher income thresholds).
- Additional aid (extending at least until June), that includes replenishment of the paycheck protection program (PPP) for small businesses, enhanced jobless benefits and direct aid to states and localities.
- A bipartisan infrastructure bill, paid for by some higher taxes on corporations and high-income individuals (though nowhere close to the rates in effect prior to the 2018 tax reform bill).
- Other smaller but popular bills that wouldn’t have even come up for vote in in the Senate under Majority Leader McConnell.
So what might these measures mean for markets and the economy? The biggest impact will be on personal income, which was already set to surge in the first quarter of this year thanks to the fiscal relief bill enacted in late December. It’s far less clear, though, that more fiscal aid will boost GDP, at least in the near term. Why? Because savings rates during the pandemic have been far higher than normal for most households, reflecting both the generous federal assistance and consumers’ inability — or reluctance — to spend this money given restrictions on commerce, travel and other activities that would spur economic growth.
For the broader economy, much depends on how quickly the vaccinations are administered and whether new COVID-19 caseloads fall. If the vaccine rollout moves slowly, we could see less of a boost to GDP and corporate profits growth in the second quarter, followed by a bigger one in the third.
Compared to a month ago, we’re expecting a much larger rise in personal income but a somewhat smaller increase in U.S. GDP growth in the first half of 2021. But we should still get the much-awaited bounce in the second half.
And although the newly flipped Senate may amp up federal spending in the two years leading up to the mid-term elections — potentially contributing to stronger GDP gains during that stretch — the Fed is likely to maintain its extremely accommodative monetary policy, both in terms of quantitative easing and the target federal funds rate. That said, a hotter economy could test the Fed’s newfound tolerance of inflation sooner than it may have expected, especially if a huge savings boost translates into a demand surge by the third quarter.
As for last week’s equity market results, any concerns that the Democrats will at some point use their dual majorities to raise taxes were quickly offset by optimism about the prospect for more stimulus in the near term.
Cyclicals, unsurprisingly, led the way. Energy surged on higher commodity prices, and financials tend to outperform when the U.S. Treasury yield curve steepens.3 (That happens when longer-term rates, which determine what banks charge for loans, rise faster than short-term rates, which influence what they pay depositors.) Last week, the 10-year yield closed at a 10-month high of 1.13%, while the 2-year finished at 0.14%.4 Sectors tied to more infrastructure spending (such as materials) or stronger U.S. consumer spending, also rallied hard. Laggards included ultra-defensive stocks (utilities, for example) and technology companies, which under a Democratic administration may be exposed greater regulation and changes to the tax code.5
So what’s our overall take given everything that’s transpired since November 3? Our unified message before, during and after the U.S. election was that the results were unlikely to be the driving factor for financial markets over any time horizon. We still hold that view. The shift in Senate control will undoubtedly have an impact on public policy in 2021, but that shouldn’t be an overriding concern for investors. We expect policy changes to be incremental, which should be neutral to positive for our outlook.
COVID-19 saps U.S. labor market’s momentum — but the news isn’t all bad
If you just read the headlines, last Friday’s release of the December U.S. employment report looked like a disaster: 140,000 jobs lost.6 There’s no sugarcoating it: The U.S. labor market ran smack into a brick wall after a few months of weakening at a more gradual pace. Looking into the data, the rapidly accelerating spread of COVID-19 was responsible for last month’s poor showing. For example:
- The number of workers on temporary layoff increased for the first time since April, mainly in leisure and hospitality jobs.7 These two areas have been especially hard-hit by the virus.
- Average hourly earnings spiked unexpectedly, but not for good reasons: most of those temporary layoffs were at the lower end of the income scale.8 In other words, it wasn’t so much that wages grew but that lots of lower-wage jobs disappeared, perversely boosting the average wage.
But looking beyond the headline, there were some bright spots:
Positive revisions (+135,000) to payroll gains in prior months essentially offset December’s job losses.9
- The unemployment rate held steady at 6.7%.9
- Labor force participation was also unchanged, which is consistent with the bulk of the layoffs being temporary.9
The number of unemployed workers who viewed themselves as having permanently lost their job dropped meaningfully, reversing a trend that started nearly a year ago. Even so, the percentage of unemployed workers who have been out of work for longer than 26 weeks continued to tick up and now stands at just over 37% (representing over 3.7 million people).10 The higher this number, the harder the recovery will be for the labor market. That’s because the longer someone has been out of work, the more difficult it becomes for them to find a new position.
It may seem incongruous to introduce optimism into a section devoted to a subpar jobs report. Yet we do believe the longer-term outlook for the labor market is still quite bright. December’s release captures a particular moment in time in which vaccines had not yet been deployed, COVID-19 caseloads were worsening nationwide and there were sincere doubts about the passage of a fiscal relief bill. But not only did fiscal aid arrive, it included additional funding for the Paycheck Protection Program (PPP), which should help more employees remain attached to their jobs at small businesses even if these companies have shut or been greatly impaired due to the pandemic.
As a result, last month’s drop in payrolls could end up being a blip in an otherwise robust recovery. In addition, stronger demand in the economy by the second half of this year should help create new jobs and potentially push up wages in labor-constrained industries like construction. That could bring a few million extra people back into the labor force.
Eight months ago, when the unemployment rate soared to 14.8%, a 5% rate by the end of 2021 seemed like a fantasy.11 But the economic recovery has been more robust than we had anticipated. Consequently, just two months ago, 5% became our “upside” scenario. Now it’s evolving into our base case. Additionally, as with its willingness to accept prospectively higher inflation, the Fed is less interested in using the unemployment rate as an indicator for how fast it should tighten monetary policy. The last time the jobless rate fell to 5% — back in 2015 — the Fed was already about to raise interest rates.12 This time around, the Fed’s planning to keep rates at 0% for a few years, at least. Hotter conditions ahead!