The US equity market reached its pandemic lows almost exactly one year ago on March 23rd, 2020. Following the dramatic market fall induced by the shutdowns, it took the S&P 500 just 6 months to bounce back to its previous all-time highs. One year on from those lows, the US equity index is up +75%. This is a remarkable turnaround for equity markets and clearly demonstrates that Mr. Market was never in very much doubt about the nature of the post-COVID economic recovery. It will come and it will be “V-shaped”.
In fact, the trajectory of the economy now looks to be so V-shaped that many market participants and commentators are worried the other side of the ‘V’ could be too steep, in other words we may see an overheating economy and high inflation. A recent survey by Bank of America found that, for more than 90% of investors, inflation is the risk that now most concerns them.
Speaking last week on this subject, Chairman of the Federal Reserve, Jerome Powell, was more cautious, saying that the recovery (while progressing faster than generally expected) was far from complete and has significant ground left to make up in the labour market. He added that the Fed would continue to support the economy for as long as necessary, and that inflation is not, presently, a concern (Fed predictions are for 2.2% this year, 2% next year, and 2.1% in 2023 and beyond… hardly eye-watering).
This is creating the push and pull factors that explain the sideways equity markets we have seen since early February. The market has priced in a strong economic expansion in 2021 (this looks like it was the right call), but uncertainty about the inflation outlook and its impact on asset prices if inflation emerges has held back markets from continuing to rally into the recovery.
We think there is news fast approaching that could be the catalyst to shake markets out of their holding pattern… corporate profits. Businesses are starting to see the recovery uptick in demand, particularly in Asia and the US, while also having adapted their business models and cost structures to the pandemic induced shutdowns. The Q1 and Q2 2021 results seasons, where companies announce their results, will likely be strong and potentially much stronger than the market has priced in.
High growth rates in profits and ebullient commentary from management teams will be hard for the market to ignore, with or without higher inflation expectations.
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