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U.S. economic growth is accelerating as vaccinations rise and social-distancing measures ease, but hopes for a long-lasting spending boom may hit a couple of speed bumps. Vaccine rollouts in major countries are proceeding at different speeds, but stock market performance contradicts what vaccination data would seem to imply for investors. Meanwhile, inflation-adjusted longer-term Treasury yields have risen as investors anticipate stronger economic growth.
U.S. stocks and economy: Moving, but with bottlenecks
With regional social-distancing measures easing, mobility is gathering steam and the path to a broader reopening is becoming clearer. Many believe that the recent massive buildup in savings will be spent quickly as the economy broadly reopens. However, we think it is premature to assume a long-lasting spending boom will emerge—not only because consumers’ spending habits may have become more prudent, but also because the math for a rebound in services is much different than for goods.
The additional COVID-19-related fiscal relief measures implemented in late 2020/early 2021 bolstered consumers’ finances. As you can see in the chart below, the personal savings rate (unsurprisingly) spiked higher after households were mailed a second round of checks at the end of the year.
Savings jumped after government stimulus checks were mailed to households
Source: Charles Schwab, Bloomberg, as of 1/31/2021.
The next round of aid—the recently-passed American Rescue Plan—includes $1,400 direct cash payments for individuals. Most people plan to save a bulk of this round of relief, followed by paying for food and housing expenses, according to a survey by Bloomberg and Morning Consult in February.
Many argue that these savings will be drawn down quickly as the economy reopens. However, pent-up demand in goods has arguably already been satisfied. The manufacturing sector has seen a marked improvement in demand and general sentiment. As you can see in the chart below, the Institute for Supply Management’s Manufacturing purchasing managers index (PMI) has stayed firmly in expansionary territory, and in February reached its highest level since December 2018. The rebound has not come without caveats, though. The prices-paid and supplier-deliveries components have surged, underscoring the disruptions businesses are still experiencing within supply chains.
Strong manufacturing sentiment, albeit with supply-chain issues
Source: Charles Schwab, Bloomberg, as of 2/28/2021.
U.S. stocks have come under some pressure recently, particularly given the rapid rise in the 10-year Treasury yield since the end of February. The Information Technology and Consumer Discretionary sectors have led to the downside, as investors continue to rotate into cyclically oriented sectors, given the prospects for rapidly-accelerating growth this year.
Stocks were arguably ripe for a pullback, given buoyant investor sentiment across nearly every metric. As you can see in the chart below, SentimenTrader’s Panic/Euphoria Model had risen to a level not seen since the technology boom in the late 1990s, before recent market weakness brought sentiment down to a zone that historically has tended to be better (but not the best) for stock market returns. A full washout in excessive optimism has yet to occur, and risks may persist if bullishness spikes again and/or market breadth deteriorates. Yet, as is always the case with sentiment, a negative catalyst is typically needed to accelerate stocks’ moves to both the upside and downside.
Euphoric sentiment has edged down from extremely high levels
Source: Charles Schwab, SentimenTrader, as of 3/5/2021. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
Global stocks and economy: Different speeds
In February, markets moved to price in the potential impacts of stimulus and the recovery, while vaccine rollouts in major countries proceeded at different speeds. The chart below shows vaccine doses administered as a percentage of the total population, revealing starkly different trajectories in these major countries since their first dose was administered. The United Kingdom was the first country to start vaccinations and remains in the lead among major nations, followed closely by the United States. In comparison, the European Union is lagging and China is far behind, showing little progress through the Lunar New Year holiday.
Vaccination is progressing at different speeds
Source: Charles Schwab, Bloomberg data as of 3/2/2021.
The vaccine-led recovery is arguably the most important factor for stock markets around the world, making this divergence a clear signal to investors about where to shift focus and where to avoid. But, as is often the case, investing isn’t that simple: The performance of the stock markets in these countries contradicts what the vaccination data would seem to imply for investors. The best-performing stock market this year has been China, followed by Europe and the U.S.; the U.K. has posted the worst performance year-to-date.
Stock market performance is reverse of rollout progress
Source: Charles Schwab, Bloomberg as of 3/2/2021. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
What drives this counter-intuitive outcome for the markets? China may be the easiest to explain. Its stock market is the best-performing in the world so far this year, even though the vaccine rollout lags other large economies by a wide margin. China’s targeted public health policy of stringent case containment using public health measures during outbreaks has been effective. This created little urgency for people to get vaccinated, while the economy has moved forward, unimpeded by broad-based lockdowns.
We aren’t suggesting the vaccine rollouts don’t matter; inoculations are very important to the global economy and markets. Rather, we point out that investors shouldn't get caught up in which country is “winning” the vaccination race.
Sales for global companies, which drive the major indexes, are dependent upon all major countries seeing a vaccine-led recovery in the second half of this year. Although the UK leads in vaccinations, UK stocks get only about 23% of their revenue domestically and are dependent on foreign trade for the rest, as you can see from the chart below. The path of vaccinations for the rest of the world is more important to the revenue of companies in the UK than domestic vaccination progress.
Global sales matter more than domestic
Revenue breakdown by country for MSCI United Kingdom Index
Source: Charles Schwab, FactSet data as of 3/3/2021.
We anticipate a ramp-up in vaccination progress in Europe in the coming months, which will contribute to its ability to reopen areas of the economy shuttered during the pandemic. The EU has secured orders for more Pfizer/BioNTech and Moderna doses, while large European pharmaceutical companies without vaccine candidates are converting factories to produce vaccines from their competitors. Strong earnings and a global economic recovery are expected later this year, prompted by mass immunizations.
Fixed income: Real rates are on the rise
Bond yields rose to the highest level in a year in early March on signs that the economy is bouncing back from the depths of the downturn last year. Ten-year Treasury yields moved slightly above the 1.6% level, the highest level in a year. With the passage of the $1.9 trillion fiscal stimulus package and the pace of vaccinations picking up, the markets are pricing in a strong economic recovery.
Most notably, real interest rates—bond yields adjusted for inflation—have been rising. After dropping to as low as -1.0% last year, 10-year real yields have moved up by about 35 basis points1 to -.0.65%. While still in negative territory, that’s a big move in a short period of time.
Rising real yields reflect optimism about the economic recovery. With the pace of the vaccine rollout picking up and another large fiscal stimulus package passed, markets are beginning to price in a return to more normal interest rate levels.
Real 10-year yields are off their lows, but still in negative territory
Note: A real interest rate is an interest rate that has been adjusted to remove the effects of inflation.
Source: Bloomberg. U.S. real 10-year yield (H15X10YR Index). Daily data as of 3/5/2021.
A positive real yield of 0.50% would bring it back to the average level seen in the five years leading up to the COVID-19 crisis. That’s lower than the historical average that prevailed before the global financial crisis, but we remain in a unique environment. Inflation has been lower and more stable, the Federal Reserve’s role in influencing rates has expanded, and there is still excess capacity in the economy. Many businesses are still shuttered or running at reduced rates, the unemployment rate is still high, and schools are not fully re-opened, limiting the return to work for many parents and local educators.
Moreover, we don’t expect the Federal Reserve to raise short-term interest rates any time soon. Fed Chair Jerome Powell has been explicit that the Fed is likely to keep short-term interest rates near zero and maintain a large balance sheet until the unemployment rate falls back toward pre-pandemic levels, even if that means inflation overshoots its 2% target. The upshot is likely to be further steepening in the yield curve as intermediate to long-term rates respond to the economy’s improving trend.
The spread between two- and 10-year Treasuries has risen
Note: The rates are comprised of Market Matrix U.S. Generic spread rates (USYC2Y10). This spread is a calculated Bloomberg yield spread that replicates selling the current 2 year U.S. Treasury Note and buying the current 10 year U.S. Treasury Note, then factoring the differences by 100.
Source: Bloomberg. Daily data as of 3/8/2021.
We expect the direction of both nominal and real yields to continue higher in the months ahead. Fiscal and monetary policies are aligned to provide the economy with the biggest boost to growth in decades. The prospect of higher real growth and increasing supply of Treasury debt should translate into higher yields.
We came into the year with a target of 1.6% for 10-year Treasury yields. Now that it has been reached, we see scope for a move up to 2% as the next target. We continue to suggest investors keep the average duration in portfolios low, but look for opportunities to buy higher-yielding bonds in the months ahead as rates rise.
1 One basis point is equal to 1/100th of 1%, or 0.01%.
Senior Investment Research Specialist Kevin Gordon contributed to this report.
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