The Most Important Number of the Week Was 1
(Bloomberg Opinion) -- Meet the new year, same as the old year. The stock market started 2021 just as it ended 2020, which is to say it staged an impressive rally in the first week in the face of what would otherwise be some obvious headwinds. So despite extremists storming the U.S. Capitol in a bid to overturn President-elect Joe Biden’s victory, talk of invoking the 25th Amendment to remove Donald Trump from office and a monthly employment report that showed the economy lost 140,000 jobs in December, the S&P 500 Index surged 1.83%, setting yet another record high on Friday.
But to close market watchers, perhaps what was most impressive is that equities overcame 1% bond yields. The yield on the benchmark 10-year Treasury note, which helps determine borrowing costs for the government, companies and even individuals, rose above that psychologically important level on Wednesday for the first time since March before ending the week at 1.12%. An argument could be made that yields well below 1% were a primary reason stocks soared last year even with a global pandemic and the worst recession since the Great Depression.
After all, nobody wants to own bonds that pay next to nothing unless they have to for regulatory or other reasons. Plus, simple discounted cash-flow analysis shows that ever lower rates make future earnings more valuable in the present, justifying higher multiples for stocks even without profit growth.
So logic dictates that a rise in yields would lead to some unwinding of bullish bets in the stock market. That may yet come, but there are a few reasons to believe it won’t happen soon. The first is that real yields, or those after inflation, are still negative, just as they have been since mid-2019, providing a big incentive to find investments other than fixed-income assets.
The second is that the Federal Reserve has no plans to stop pumping at least $120 billion a month into the financial markets through its bond purchases to support the economy. As noted above, that money will likely gravitate from the debt market into other assets because few investors like to own bonds that pay no yield if they don’t have to own them.
The third is that the unification of the White House, Senate and House under the Democrats increases the likelihood of another fiscal stimulus package that puts $2,000 directly into the wallets of many Americans almost immediately after Biden’s inauguration. “Politics play second fiddle to economic and corporate fundamentals when it comes to setting asset prices. The country’s economic future coming out of the pandemic remains promising,” Nick Colas, the co-founder of DataTrek Research, wrote in a recent note to clients.
These payments will likely supercharge the economy. With the unemployment rate at 6.7%, it’s not as if Americans couldn’t use the help to pay for necessities. Rather, it comes when excess savings have ballooned thanks to previous stimulus and generous government benefits. My Bloomberg Opinion colleague Tim Duy has noted that excess savings in the economy probably totals a record $1.4 trillion. That’s a sum that could quickly rise to $2 trillion, RBC Capital Markets Chief U.S. Economist Tom Porcelli wrote in a recent research note.
It may be just an anecdote, but a recent Bloomberg News interview with Albert Lewis III is telling. The 19-year-old Iowa State University student said he had already decided that the $600 he will receive from the most recent relief package will be going into his Robinhood investment account.
“The $600 isn’t needed at this moment,” Lewis said. “I’m investing it hopefully to turn it into something more than that by the time I’ll need it. $600 in a year isn’t going to turn into $10,000, but if I invest it now, in 40 years it’s going to be worth way more.”
Sure, there are plenty of things that could reverse bullish tendencies. For starters, Democrats only have a slim majority in the Senate, and an aide to West Virginia Senator Joe Manchin signaled on Friday that the Democrat isn’t ready to automatically vote for more direct aid payments. And Biden has vowed to increase income taxes, capital gains taxes and payroll taxes for people making more than $400,000 a year, as well as for corporations, moves that could dampen animal spirits.
But as long as the government and the Fed are showering the economy with free cash, it’s hard not to be bullish. And that’s true even if bond yields continue to move higher.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is the Executive Editor for Bloomberg Opinion. He is the former global Executive Editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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