The convergence of ultra-easy fiscal and monetary policy with global supply chain disruptions, which became ever more prominent as U.S. consumers, having saved around 8% of GDP began to unleash their pent-up demand, resulted in inflation indicators and debates exploding higher.
Much of the macroeconomic enthusiasm investors were gearing up for in the first quarter became reality in April. U.S. GDP (+6.4%), retail sales (+9.8%), ISM manufacturing (64.7) and housing starts (+19.4%) reports all came in at the best readings in decades. A record-breaking start to the corporate earnings season further boosted sentiment as 87% of the companies reporting beat earnings estimates by an average of 24%. The U.S. economy was confirmed to be “red hot,” as Warren Buffet noted. It was not all good news though as distribution of the Johnson & Johnson vaccine was halted in the U.S. for an additional review of rare side effects, and the rest of the world struggled with their own vaccine distributions. However, with one third of the U.S. population having received at least one dose of the vaccine and approximately 20% already fully vaccinated, markets shrugged off the temporary setback and focused squarely on the accelerating economic recovery. The Nasdaq led the equity market gains for the month, picking up 5.40%, with the S&P 500 close behind at 5.24% and the DJIA adding another 2.71% to its gains.
April also capped President Biden’s first 100 days in office and demonstrated that the new administration is not afraid to spend big and tax big. Following up on last month’s infrastructure proposal, Biden announced another $1.8 trillion in spending called the American Families Plan. This new initiative together with the infrastructure plan, if passed, would be in addition to the $5.5 trillion that has already been spent by Congress targeting the pandemic recovery. Combined, U.S. stimulus is now tipping a whopping $10 trillion and is larger than the rest of the world combined. The new plans also outlined proposals to increase the corporate, top marginal income and capital gains tax rates in order to pay for the spending, creating new looming headwinds and questions for corporate America and investors alike.
The convergence of ultra-easy fiscal and monetary policy with global supply chain disruptions, which became ever more prominent as U.S. consumers, having saved around 8% of GDP began to unleash their pent-up demand, resulted in inflation indicators and debates exploding higher. Prices of copper, lumber, soybeans, corn and other commodities registered double-digit growth year-to-date. Mentions of inflation during earnings calls more than tripled year-on-year in the biggest jump in history. Despite Chairman Powell’s and other Federal Reserve members constant and consistent assurances that the upward pressure on prices would be “transitory,” corporate CEOs commented en masse that “inflation is here, it is real, and it is significant.” Perhaps the central bank knows something the rest of us do not….?
Despite this background, rates were contained and well behaved as fixed income investors seemed to fade the booming economic data. 10Y Treasury yields backed off by nearly 20 basis points and back below 1.60%, making some wonder if this was a signal that data is peaking. From our perspective, this retracement was largely a function of technical and seasonal factors, driven by foreign investor demand and domestic short covering. The drop in yields combined with spread narrowing across many asset classes pushed traditional fixed income total returns in April into positive territory, though year-to-date they remain mostly negative. Leveraged credit continued to outperform as the loan market resumed its climb after a pause in March. The S&P LSTA index rose 0.51% in April, bringing year-to-date returns to 2.32% with accelerating economic reopenings, improving fundamentals, growing inflation anxiety and a search for yield driving demand for the asset class, especially at the riskier end of the spectrum as the lower quality rally, which has been a defining trend in the market for the past 12 months, continued unabated.
The inflation debate, much like inflation itself is likely only heating up. Questions around the transitory nature of widespread price pressures and the Federal Reserve’s policy response, or lack thereof, are certain to worry markets in the coming months. Revaluation shifts and bouts of accompanying volatility are likely to persist and test investor confidence. We believe that the rotation into short duration, floating rate assets out of duration exposed, fixed rate instruments in order to buttress portfolios against these inflation, rate, duration and policy headwinds will continue to gain pace and buoy both institutional and retail flows into the loan asset class in particular.