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:
“Nothing in the universe can stop you from letting go and starting over.”—Guy Finley
With little fanfare, the Fed caps a memorable year
Ahead of the Federal Reserve’s final 2020 meeting last week, we thought Chair Jerome Powell and his colleagues were likely to lengthen the average maturity of the U.S. Treasury securities it buys each month by targeting larger purchase amounts of longer-duration issues. That would have put downward pressure on longer-term yields, helping to keep rates on mortgages and other loans tied to Treasuries from rising. But the Fed declined to take that step.
The Fed also decided against increasing its monthly quantitative easing (QE) bond-buying program. In our view, doing so would have sent a signal to markets that the economy is in need of strong medicine. (The labor market has indeed been weakening recently, although manufacturing and service-sector activity remained healthy in December.)
In its policy statement, the Fed adjusted its primary rationale for its QE purchases during the pandemic. The program was launched with urgency in mid-March to help foster functioning financial conditions in the early days of the coronavirus outbreak in the U.S. and the economic damage it caused. Now the Fed views QE as a means to promote continuing accommodative monetary policy. This subtle change likely indicates not only that QE will last well beyond the end of the COVID-19 crisis, but also that it will persist at least until (1) the U.S. is on track to achieving full employment or (2) inflation is primed to accelerate beyond the Fed’s 2% target. It’s worth noting that the Fed doesn’t anticipate inflation to average 2% until 2023, with interest rates expected to stay at current levels (0%-0.25%) at least through 2023.
The Fed also upgraded its outlook for the U.S. economy, while noting that the virus still represents a significant near-term risk. Among its revisions, the Fed:
- Raised its median GDP growth forecast to -2.4% for 2020 (versus -3.7% in September) and to +4.2% for 2021 (from +4.0% in September).4
- Lowered its expectations for the unemployment rate, to 5% by the end of 2021 and to 4.2% by the end of 2022.4
What’s our take on the Fed’s latest policy statement and outlook?
The Fed has made clear that its objective is not merely to provide emergency relief during the pandemic, but also to ensure that the U.S. economy returns to its former strength as quickly as possible after the crisis subsides. This echoes the Fed’s September pledge to not raise its benchmark federal funds rate until inflation seems likely to overshoot the 2% target.
A combination of increased fiscal spending and loose monetary policies should eventually help the economy run hotter, resulting in lower unemployment, higher labor force participation and rising wages for a broader cross-section of the workforce.
The fourth quarter in review
And what a quarter it was! The year’s final three months were marked by investor optimism that effective COVID-19 vaccines will overcome the near-term health crisis and economic fallout. Here are some key trends and developments we saw during the period:
The darkest hour may be right before the dawn. According to the New York Times, last Wednesday the U.S. set records for single-day COVID-19 fatalities (more than 3,600) and newly reported cases (more than 245,000).5 But that catastrophic news was tempered by reports that individual states had begun to distribute the recently approved Pfizer vaccine to health care workers. Then, this past Friday, the FDA authorized a second vaccine, developed by Moderna, for emergency use.
The Eurozone’s “two speed” economy. Manufacturing activity in the region expanded in October, November and December, when it reached a 2½-year high.6 This strong performance was fueled by rising exports, particularly from Germany, the eurozone’s largest economy. Meanwhile, the service-sector continued to struggle amid social distancing requirements that may remain in place for a long time to come.6
U.S. shows signs of softening. Retail sales fell a worse-than-anticipated 1.1% in November and were revised downward in October, from a modest gain to a slight loss.7 Discouragingly, the labor market, after building momentum throughout the summer, began to lose steam. November job creation badly missed forecasts, and first-time weekly jobless claims, which had been dropping from May through October, have started to pick up again.8 The failure of Congress to pass a second fiscal stimulus bill likely exacerbated the magnitude of the current economic pullback.
China forges ahead.
The world’s second-largest economy has already seen its early rebound turn into a durable expansion. November’s 5% year-over-year gain in retail sales was the highest in almost a year. Additionally, China’s manufacturing activity has expanded for seven straight months, to its best level in a decade, and the service sector has also been on a powerful upswing.9
The S&P 500 shows that records are made to be broken and broken. For the fourth quarter to date, the S&P 500 has surged 10.7%, notching nine new all-time highs along the way.10 Investors have been pricing in a much improved economic picture next year, anticipating that vaccines will end the pandemic and rapidly normalize the economy. A third-quarter rotation into more cyclical (economically sensitive) areas of the stock market such as technology and energy, continued into the fourth quarter. Among companies of different size, small caps have risen an eye-popping 31.1% for the period, easily outpacing the otherwise stellar results of large caps (+12.5%) and mid caps (+19.6%).11 Smaller firms tend to see the biggest bounce as the economy emerges from a recession.
Little movement for the 10-year U.S. Treasury yield. After beginning the quarter at 0.69%, the yield on the bellwether 10-year Treasury note reached 0.90% by early November as election uncertainty eased and hopes for more fiscal stimulus grew.12 But the 10-year yield has barely budged since then, closing at 0.95% on December 18. The clear softening in U.S. labor market data has kept interest rates pinned down despite the run of good news on vaccines. With rates so low, and the Fed poised to keep them there for years to come, demand for higher-yielding non-Treasury sectors has increased— leading to healthy returns for high yield bonds (+5.8%), investment grade bonds (+2.3%) and emerging markets debt (+4.1%), among other asset classes.13
To Our Readers: This will be our last edition for 2020. We look forward to publishing again on January 4, 2021.