Powell Says all the Right Things, Markets Pout Anyway

March 5, 2021

It was another tough week for markets as bond rates continued to climb. The U.S. 10-year treasury yield closed the week at 1.58%, up 0.65% from the beginning of the year. The move spurred investors to continue to flee interest-rate sensitive, long-term bonds and high-flying growth stocks, while the rotation into economically sensitive stocks continued. The week’s economic data strengthened the reopening theme as the Covid vaccine rollout continues to gather steam. The hospitality industry, having taken the brunt of layoffs over the last year, boosted their February hires, pushing the month’s payrolls gains to 379,000. U.S. manufacturing and services also continued to build momentum on strong demand. Overseas, China’s factories experienced a minor slowdown as other global manufacturers have started coming back online. For the week, the tech heavy Nasdaq fell -1.92%.   

Hospitality Sector Drives February Jobs Gains

After a dismal 2020, the hospitality sector showed fresh signs of life in February as Covid rates started to decline and consumers began normalizing their services consumption. The sector added 355,000 new hires during the month. Bars and restaurants led the gains, adding 286,000 jobs. Hotel-related businesses added 36,000 while amusement, gambling and recreation businesses added 33,000. The strong gains in the hospitality sector helped push the overall increase in new hires for the month to 379,000, surpassing economists’ estimates of 210,000. Despite the job gains, the unemployment rate remained little changed from February, holding at 6.20%. The job gains were a welcomed reading, but the job market still has substantial room for improvement. An estimated 8.5 million fewer Americans remain unemployed compared to a year ago with the labor force participation rate at 61.4%. The labor force participation rate remains down 1.9% from year ago levels. The figures are consistent with the Fed’s messaging with respect to the labor market and its commitment not to raise rates until it sees widespread improvements across industries and income levels.  

Strong Factory Activity and Service Activity Point to More Economic Gains

U.S. manufacturers continued to rev in February as the ISM Manufacturing Index rose to a 2-year high of 60.80. Readings above 50 indicate expansion while numbers above 55 are considered exceptional. February’s reading was the index’s fastest pace since the onset of the pandemic. New orders, production, and employment all rose during the month. New orders led the gains, hitting 64.8 while production increased to 63.2. Employment also climbed closer to exceptional levels, hitting 54.4 in February. That was up from 52.6 the month before. Meanwhile, the services sector slowed in February, dropping to 55.3 from 58.7 the previous month. That slippage has to be taken in context however given the brutal winter storms that hit the nation recently, leaving millions without power and water for up to a week. The spring thaw should prove favorable for services and manufacturing alike.

China Manufacturing Slows as Global Factories Resume Production

China factory PMI fell to 50.6 in February, down from 51.3 in January. New export orders, which had been a source of strength, fell below 50 for the first time since last August. The drop does not come as a complete surprise given that U.S. and European factories are resuming more normal business operations. The weakness in Chinese exports should be short-lived given that U.S. manufacturers, in particular, have struggled to fill depleted inventories amid strong consumer demand for goods. That bodes well for Chinese exporters as they have the spare capacity to fill in the gap to meet consumers’ needs.    
The S&P 500 struggled to find its footing this week, heading towards its second consecutive weekly loss before a late day rally helped the index finish the week up 0.82%. The index’s heavy tech weighting – which has benefited the index over the past ten months – has now become a drag on performance. Rising interest rates reduce the intrinsic value of long-dated, future cash flows which are inherent to both growth companies and long dated bonds. However, the real question facing investors is interpreting what the market’s repricing of interest rates really means. One camp has it that the rise in interest rates is really the bond market’s way of signaling that higher inflation is expected in response to the massive amount of additional money that has been pumped into the economy, both through monetary and fiscal actions over the last year. Inflation is kryptonite to equities because it increases costs but doesn’t provide any real growth on earnings. The other camp, which we tend to lean towards, is that the rise in rates is really a repricing in real terms and the bond market is simply tired of being the equity market’s patsy by accepting negative real returns so that the equity markets can continue to rally. A 10-year U.S. Treasury yield at 1.58% is hardly considered high, and it is barely breakeven with PPI and CPI over the last decade. 
Fed Chairman Powell tried this week to use his final public appearance prior to the Fed’s next policy meeting to dispel any concerns that the Fed might be worried by inflation or by the rise in interest rates generally. He could not have been clearer that the Fed believes the economy remains a long way off from their inflation and employment targets and has no intention to raise rates over the foreseeable future. This was not enough for markets, who had hoped the Fed would backstop equity markets by shifting its open market operations (i.e. buying long dated bonds, selling short dated bond) to reduce longer term interest rates. In effect, the equity markets want the Fed to do its bidding now that the bond market itself has shown that it is no longer willing to do so. A big part of the Fed’s new policy approach announced last year was to focus on longer-term average inflation and it was designed to get the Fed out of tinkering with current market rates the way they had in the past. This week’s volatility is just another example of the equity market having a hard time accepting that reality, and while certain sectors are being heavily impacted, the broader market is still holding up quite well. 
The Week Ahead
With bond rates rising, inflation has been on Wall Street’s mind. We’ll get the latest reports on consumer and producer prices. In overseas news, we’ll check in on the Eurozone as it releases industrial production figures.


Animal Spirits

In the world of finance, the term animal spirits is used in relation to market psychology. The term was coined by the economist John Maynard Keynes in 1936 to describe how human emotions affect financial decisions in times of economic stress or uncertainty. Keynes is considered a pioneer in behavioral economics. If spirits are low, then confidence will be low and that can dampen economic growth. If spirits are high, then confidence among consumers will be high which can be a boon to the economy. 
Economists use the Consumer Confidence Index (CCI), a leading economic indicator, to measure the degree of optimism people have regarding the overall state of a country’s economy and their own financial situations. When people feel confident about the stability of their incomes, it influences their spending and saving: they are less likely to save and more inclined to spend money. When people lack confidence, they tend to save more and consume less. In the U.S., about 70% of the U.S. Gross Domestic Product (GDP) is the result of consumer spending. The country’s $20 trillion economy relies on people buying goods and services. With hope for an end to the pandemic and the rollout of vaccines, the data shows that Americans are growing more confident about their personal financial situation and about the economic outlook. 
It was reported last week that consumer confidence improved in February after three months of declines. The CCI was 91.3 in February, up from 88.9 in January and 88.6 in December. This is still off of the pre-pandemic levels that were over 100, but it indicates a boost in consumer confidence towards the future. As we shared in last week’s commentary, government stimulus and unemployment benefits helped boost personal incomes up 10% in January which was the biggest gain in nine months. Consumers are currently flush with cash: the U.S. personal savings rate surged to 20.5% in January 2021, up from 13.4% in December 2020. Americans now have an estimated $3.9 trillion in savings which is up from $1.38 trillion in February 2020. Consumer spending in January, driven by the second round of stimulus, drove retail sales above analysts’ expectations across every major category of spending. It was a marked change after months of declining sales. The travel industry has gotten a boost as well with the industry reporting huge increases in bookings since the vaccine rollout began. With another stimulus package expected to pass in the Senate over the weekend, there certainly is hope that the animal spirits will be unleashed.



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