As we all look forward to wrapping up one of the longest years of our lives, 2020 is ending on a note that few could have seen coming. Nine months ago, the markets were plumbing the depths of despair and now, by many measures of stock market sentiment, the US markets have entered euphoria brought about by anticipation of oncoming vaccines that will then usher in a strong economic rebound in 2021.
The below chart is the Panic/Euphoria model by Citigroup, which has moved into the Euphoria zone, where historically twelve-month forward returns for equities have been negative. It is possible that the market has already pulled forward much of the returns attributable to the good news around the vaccines.
Even the most recent disappointing jobs report could not deter a rallying stock market and a falling bond market as investors placed bets that labor market pressures would eventually force politicians to keep the stimulus taps open. As one Bloomberg reporter called it – “a perfect miss”. It may not be so easy to pass stimulus, but the markets have been reacting as though it will be forthcoming.
As the economy has stopped surprising to the upside, the stock market has continued to do so. The chart below shows the directional divergence in the Citi Economic Surprise Index (trending down, a negative for the economy) and the S&P 500 (trending up, i.e. a rallying stock market).
The consensus appears to be that “risk on” is the only stance to take. However, as the Merrill Lynch legendary chief strategist Bob Farrell pointed out with rule number 9 of his 10 Market Rules to Remember, “When all the experts and forecasts agree – something else is going to happen.” See all his rules below:
While we believe that the consensus picture for a strong economic rebound in 2021 looks most likely, there is still risk between today and that rosy picture unfolding later next year. With weakness in the labor market, the economy continuing to surprise to the downside and Congress still wrangling over fiscal stimulus, the Federal Reserve may again be forced to provide the intervening boost the economy needs until the fiscal agreement comes to pass. The method they may use to provide this boost could come from shifting the maturity of their bond purchases rather than increasing their bond purchases. By shifting their bond purchases, which are currently running about $80 Billion a month, from the short maturities (less than 5 years) to buying longer maturities (7 – 20 years), they can keep a cap on longer-term rates which would be a positive for risk assets and the economy.
As we say good riddance to 2020, which the chart below highlights was more stressful for 60% of Americans, we look forward to a happier and more balanced 2021.