In this article we review:
- Major market events and developments that have transpired during the first month of 2021, including GameStop and the Reddit Rebellion
- The likely pace of economic growth in 1Q 2021 and its potential impact on the markets
- The outlook for passage and implementation of additional fiscal economic stimulus
- The overview of the January Federal Reserve meeting and ongoing monetary stimulus
- The risk of a market correction between now and the end of 1Q 2021
- Pending market catalysts and why we believe 2H 2021 will prove to be strong for the economy and the markets
Acclaimed best-selling author Roald Dahl once said, "If I had my way, I would remove January from the calendar altogether and have an extra July instead."
As if this type of challenging sentiment were not enough, January 2021 experienced perhaps the strangest of bookends. The month began with an assault and riots waged upon the U.S. Capitol and ended with a social media-organized short squeeze aimed at hedge funds, sending a group of relatively innocuous stocks, most notably GameStop Corp., to stratospheric price levels unimaginable in any parallel universe. Simply put, history can offer no similar precedents to either of these.
Yet these two events notwithstanding, the markets have now officially put January behind them, but not absent a few bruises that could take some time to heal in the months ahead. However, we do not find this at all surprising. In our 2021 Market Outlook, we expressed that the first quarter could be challenging for investors as markets look to cross a bridge between slowing economic growth in the early months of the year and a substantially more-favorable turn to higher growth in the spring and summer as vaccine distribution ramps up and fiscal stimulus filters through the system.
As we look ahead to warmer months and potentially fewer uncertainties in the markets, investors will want to fully recognize some of the important events and developments that have occurred in recent days and how they might set the stage for the 11 months to follow.
The Reddit Rebellion and GameStop phenomenon has taken the world by storm. It is hard to describe the final week of January as anything other than stunning and shocking as a virtual army of about six million mostly Millennial-aged retail investors blasted trades in mass volumes to squeeze short stock positions on some of the world’s most successful hedge funds. Organized through the chat room “WallStreetBets” on the social media site Reddit, this highly orchestrated trading community inflicted huge losses on numerous hedge funds and, in the process, sent a group of a dozen or so stocks into orbits beyond any rational measure. This included GameStop (GME), a chain franchise of video game stores that saw its stock price skyrocket from $61 on January 25 to an intraday of more than $400 just three days later. While this strange and bizarre series of events has certainly created noticeable market disruption and short-term volatility, in our opinion it does not represent systemic risks to the broader markets. (For a more detailed account, please see our related article “GameStop, the Reddit Rebellion, and What Investors Need to Know.” )
U.S. economy showing signs of slowing as markets await wider vaccine distribution and fiscal stimulus. On January 28, the Bureau of Economic Analysis released its advanced estimate on 4Q 2020 U.S. gross domestic product (GDP) displaying annualized growth of 4%. This was modestly below consensus expectations of about a half-percent higher and now heightens anticipation of 1Q 2021 GDP that may wind up struggling to reach positive growth given rising virus cases, increasing business closures, slower-than-expected vaccine distribution, and a lack of additional fiscal stimulus still not yet passed by Congress. The economic landscape for 1Q also follows December’s directional change back into negative job growth and the second consecutive decline in monthly retail sales. Should the economy fall into negative GDP growth in 1Q, this could further pressure markets.
Congress prepares for passage of much needed fiscal economic stimulus, however negotiations could elongate timing. Now two weeks into President Biden’s new administration, congressional passage of additional fiscal economic stimulus is rightfully taking center stage. Days prior to his inauguration, President Biden announced plans to put forth the “American Rescue Plan,” a $1.9 trillion economic package focusing on immediate financial relief to individuals and families, assistance to local governments and small businesses, and pandemic response efforts including the national vaccination program. However, in recent days, a group of 10 Republican senators have announced they will be bringing forward what they have called a “more targeted package” of a smaller total dollar amount. It is unclear at this point how negotiations might proceed on these differing versions and if they might impact widespread agreement that time is critical in terms of launching additional stimulus into the economy. The longer approval might take on a new package, the more challenged 1Q economic growth is likely to become.
Federal Reserve meeting reaffirms expectations on interest rates and open market activity. On January 27, the Federal Reserve, as expected, kept the Federal Funds rate at its current target range of 0–0.25% and maintained its schedule of monthly open-market, large-scale Treasury bond and mortgage-backed securities purchases of $120 billion. In his post-meeting press conference, Chairman Jay Powell reiterated the committee’s view that the pace of economic recovery was currently moderating and that, in his words, “The pandemic still provides considerable downside risks to the economy.” He also reiterated the Fed’s position that currently benign inflation would need to rise and sustain itself above the Fed’s longer-term target of 2% for some period in the future before any policy action would be taken. Aside from Chairman Powell dodging a question on GameStop stock trading and its potential impacts on the markets, there were no real surprises at this meeting. We continue to view the Fed’s existing monetary policy stance, both in terms of interest rates and large-scale asset purchases, as being a meaningful catalyst for the markets in the year ahead.
Clinical data released on new single dose vaccine. On January 29, Johnson & Johnson (JNJ) released Phase III clinical trial data on its COVID-19 vaccine candidate, showing an overall efficacy rate of 66% in preventing the virus globally, 72% in the U.S. but perhaps most importantly an 85% prevention of severe cases. While many were quick to point out this seemed to pale in comparison versus the currently approved Pfizer and Moderna vaccines (both at approximately 95% efficacy), this data is nonetheless impressive by overall historical vaccine standards and should be more than sufficient to support FDA approval in the weeks to come. Moreover, as the first available single-dose vaccine — and one with a favorable storage profile — JNJ’s new entrant should meaningfully help the national effort to vaccinate wider segments of the population in the months ahead. This is a welcome development as recent vaccine dissemination on a national level has fallen behind initial expectations.
In summary, we believe the markets could be vulnerable to more volatility and downside price risk in the next few months based on short-term economic slowing and other uncertainties, such as continued rising virus cases, the progression of vaccine distribution, fiscal stimulus passage, and the bizarre Reddit Rebellion-effected stock trading patterns. Taking these factors into consideration, as well as the strong appreciation in stocks since March of last year, we would not be surprised to see a correction in the major stock indexes of 10% or more between now and the end of 1Q.
However, given where we see potential market catalysts for the 2H 2021, we would likely view any such downside activity as an opportunity for investors. This judgment is based on:
- Strong economic resurgence in 2H 2021 potentially returning aggregate GDP back to pre-virus levels as vaccines achieve wider national distribution
- A similar-type recovery for annualized corporate earnings growth in CY 2021 also potentially exceeding pre-COVID profit levels for underlying S&P 500® companies
- The eventual passage of fiscal economic stimulus from Congress and its implementation into the economy
- Continuing accommodative monetary policy from the Federal Reserve
- Reasonable-to-attractive valuations in the equity and credit markets based on the comparisons of stock earnings yields and bond coupon rates to long-term, risk-free interest rates
Markets have now moved beyond the cold month of January, albeit with a handful of bumps and bruises perhaps likely to leave some marks over the next few months. Investors may need to be patient and disciplined as downside volatility could play out along with short-term economic slowing and a few other uncertainties. However, we continue to believe the 2H 2021 is likely setting up well for the economy and the markets. We continue to see coupon-type total returns in the high-yield and investment-grade bond markets, and we maintain our 2021 year-end price target on the S&P 500 of 4,200.
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