Markets & Research
As vaccine distribution gains speed, so does economic optimism

It’s often been said that the stock market is a study in contrasts — and that’s rarely been truer than in the coronavirus era. A year ago, equities were seized by fear that an emerging pandemic would trigger a financial plunge. Fast-forward 12 months and share prices have mounted a sterling recovery. That’s due in no small part to the vaccine rollout stirring visions of family reunions, indoor dining and stores brimming with shoppers.

There’s still a ways to go until that becomes a broad reality. A premature return to socializing could feed an outgrowth of COVID-19 variants. And the financial markets face a pickup in interest rates and fear of inflation. Still, the signs of medical and economic progress are unmistakable, and they raise the possibility of growth revving to its highest level in several decades.

A handful of interlocking forces are driving the U.S. economy. Accelerating vaccination programs have begun to rekindle consumers’ willingness to make airline reservations, schedule salon appointments and renew gym memberships. Americans have ample cash to pour into those once-quotidian activities because personal savings swelled as lockdowns reduced spending opportunities.

Personal savings rate

Underlying it all is the $1.9 trillion virus relief package that President Biden signed into law in March. Combined with two earlier rounds of stimulus, the government measures dwarf those of the past in both absolute terms and as a share of GDP.

The stimulus measures are cascading through the economy. The U.S. added 916,000 jobs in March, including notable gains in beleaguered sectors such as leisure and hospitality. Consumer sentiment hit its highest level since the pandemic began. Growth projections have soared, with the Organization for Economic Cooperation and Development predicting the U.S. will expand 6.5% this year, twice the level expected in November.

Global real GDP growth projections (%, year-over-year)

Stocks reflect that enthusiasm, with the S&P 500 up 81% from its bear market low in March 2020. Signs of an economic broadening have revived the fortunes of cyclical sectors such as energy, financials and industrials. Value stocks are outstripping growth shares so far this year while the technology leaders that dominated in 2020 take a breather.

Coronavirus variants top the list of unknowns.

Of course, the economy is far from regaining its pre-virus luster, and several forces could dim the stock market’s path. COVID-19 variants that have cropped up around the world pose a big unknown. More contagious forms of the virus could blunt the public’s still-fragile comfort in resuming pre-virus routines.

There is also concern that buoyant growth could set off inflation. At a time when central bank stimulus campaigns have produced an unprecedented expansion of the money supply, there is fear that the Federal Reserve is relaxing its historical vigilance against inflation. The Fed adjusted its inflation approach last summer, saying it might let price increases temporarily exceed their intended level following a period when they were exceedingly low.

Then again, policymakers have spent years trying to boost inflation, to no avail. Even an unemployment rate at a half-century low last year had little effect. And the output gap — basically, the difference between where the economy stands today and its potential — is large. That suggests that spending and employment have room to grow without forcing prices higher.

Nowadays, bullishness itself is casting a shadow. Retail investors flush with time and cash have been in thrall to so-called meme stocks — often-distressed companies such as video game retailer GameStop that are touted in internet chat forums. Assets ranging from bitcoin to digital art and sports trading cards have spiraled upward. The enthusiasm extends to special-purpose acquisition companies, or SPACs, which are shell companies that raise money to list on an exchange in the hope of taking private companies public.

In the broad equity market, valuations have risen in growth-oriented areas such as tech. Overall, however, valuations continue to be reasonable, particularly in the roughly two-thirds of the market that investors darted past during last year’s infatuation with growth stocks.

Our portfolio managers have been attracted to areas of the technology sector that are expected to benefit from society’s ongoing digitization. Like other picks and shovels of the electronic age, IT consulting and integrated circuits are both in demand across industries.

Bond yields remain moderate despite economic vigor.

The pickup in growth, coupled with a rise in government borrowing, has pushed up bond yields. The 10-year Treasury note finished the first quarter at 1.74%, up from 0.92% at year-end.

However, that is still below the T-note’s 1.92% at the end of 2019. Thanks partly to the slack in the economy, bond yields are expected to remain at historically low levels. The Fed has repeatedly pledged to keep interest rates low. Fed Chairman Jerome Powell has said he doesn’t think the $1.9 trillion virus relief package will cause inflation to surge, and that the central bank can respond quickly if prices spurt higher.

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