Markets Could See Best Growth in Four Decades

By Ketu Desai

The market rebounded in February after taking a pause in January. Market participants are starting to price in a stronger and a quicker recovery than previously expected. Consensus GDP growth estimates for 2021 are up to 4.9 percent, up from 4.3 percent in January. Growth estimates are as high as 7.7 percent. We could see the best growth in 40 years. We have seen blowout economic data across both manufacturing and retail. Empire manufacturing came in more than double the expectation, with particular strength in new orders and capex expectations. Deere, a bellwether for agriculture and manufacturing, raised its fiscal 2021 guidance by 25 percent. Retail sales came in at 5.3 percent versus a 1.2 percent expectation, every major spending category saw gains. S&P earnings are already above their pre-pandemic high. The magnitude of beats is very impressive, 65 percent of companies have beat EPS by more than a standard deviation, ranking just behind 3Q 2020 as the best quarter in at least 23 years. For 2021, earnings are expected to grow 23.6 percent, on 9.1 percent revenue growth with cyclicals expected to grow earnings by just under 30 percent.

With stronger growth, the market is increasingly starting to factor in higher inflation. PPI came in the strongest since 2009. Market-based estimates of inflation are also moving up. 10YR break-evens are up to 2.15 percent, above the Fed's 2 percent target. Commodity markets are also expecting more inflation. We have record lumber prices, iron ore prices are at a 9-year high, tin is up 80 percent in a year, copper up 50 percent at a 9-year high, crude is above $60. Chairman Powell made, what I think was an important speech during the month, in which he spoke about the Fed working to improve inequality. His comments from a policy perspective mean that the Fed is going to let the economy run until cyclical slack is close to eliminated, this is a notable change from the past. Historically, the Fed has tightened in anticipation of low unemployment and / or higher inflation, now they are going to wait for it to come and sustain, before they move. I think the market has noticed this change, and continues to reallocate to inflation-oriented assets.

As investors rotate into more inflation-oriented assets, one of the areas that has really been hurt has been the defensive yield-oriented names. This includes sectors such as utilities, consumer staples, real estate, telecom, and healthcare. It includes some blue-chip names that are down for the year such as Proctor & Gamble, Merck, Pepsi, Costco, UnitedHealth, Walmart, and Verizon. Many of these are down enough to cost you more than a couple of years of dividends. Duration- oriented tech and biotech also had a shake-out late in the month. It remains to be seen how tech will perform as rates rise. The broader markets are likely to continue to perform well as rates rise. In 13 of the 16 postwar periods of rising rates, stocks were up, with an annualized return of 13 percent. Yields would have to rise substantially to be competitive with stocks. Even with nominal yields nearly triple the lows of last year, the real yield is still negative 60 bps. At the very least, the real yield needs to be positive for a meaningful rotation back into bonds. Within stocks, the market is telling you that you want the barbell of financials, energy, travel & leisure, and materials with cyclical tech, such as semiconductors, travel-oriented tech, and certain consumer and enterprise tech.

Looking forward, the investors will continue to focus COVID trends, economic data, rates, and the latest on fiscal stimulus.


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( ), an investment management firm based in New Jersey.