During a choppy and volatile first quarter for the financial markets, stock prices were able to achieve new records and build on the strong finish of 2020. It has been about twelve months since the onset of the pandemic, a period that has featured an unlikely 56% rise in the S&P 500 as markets rebounded from the previous year bear market and global economic recession. In hindsight, the business contraction endured last year was the most severe since the 1930’s, culminating in the temporary loss of over 22 million jobs for American workers alone.
While the vaccine rollout has been good for the psyche of consumers at large, President Biden’s $1.9 trillion COVID-19 relief package is giving businesses and the financial markets an additional boost. With the reopening of the economy, U.S. GDP growth is expected to exceed 5% in the second half of the year and find additional support from the Fed’s easy monetary policy stance of sustained low interest rates for the intermediate future.
However, as business activity picks up inflation is becoming a growing risk to the economy. Surging oil prices combined with labor and material shortages are increasing the costs of doing business, particularly in the manufacturing sectors of our economy. With increasing inflation concerns comes rising interest rates, as bond investors demand higher fixed income yields to compensate themselves for the threat of higher prices in the future. The ten-year U.S. Treasury bond, for example, has seen its rate rise from .50% to 1.75% in the past year. Higher interest rates can also weigh on stock prices, as investors looking for income gravitate towards higher yielding U.S. Treasury bonds as a substitute for dividend paying stocks.
Looking ahead there are significant policies and new programs being debated in Congress as they seek to rebuild the economy. A $2 trillion U.S. infrastructure proposal seems to have momentum, as well as a plan to raise taxes on corporations (with the tax rate potentially rising from 21% to 28%). The stock market is bullish about the former plan which has contributed to the S&P 500’s nearing the 4000 level for the first time. But with soaring equity prices comes high expectations, making this quarter’s corporate earnings reports the first of many challenging tests for the market. While there is much to be optimistic about, we will not lose sight of the obstacles facing this bull market which has been one of the most resilient and rewarding on record.
