Stocks Scared by Faster or Slower Economy

As virtually all major US stock indices rallied yet again to all time record highs in March, worry levels surged along with interest rates over a fear of an overheating economy that would lead to tighter credit conditions. Tech stocks became the canary in the credit yield coal mine as the Nasdaq 100 (QQQ) sold off 12%.  Red hot tech stocks thrive on low rates and cheap credit. In addition, fungible money flows often sell overbought tech stocks when rates rise as they shift to smaller cap and classic economic reopening sectors (financials/industrials).While some premature heart palpitations deserve a degree of concern, as we highlighted in recent reports, stocks and interest rates can rise at the same time. Thus by itself, higher borrowing costs are not a reason to panic while the economy is only in 1st gear.

Turning this hotter economy is bad thesis on its ear, due to interest rates fears, is the new concern this week that a resurgence of Covid in Europe with new economic lockdowns will stall the economic growth forecast. Should Eurozone restrictions grow and even hint at spreading to the US, it would send a brief chill down the spine of stimulus rich stock investors. All of Europe is experiencing a Covid 3d wave in cases, as exemplified below by France and Italy. Most countries are restricting domestic travel and shutting down in general until early to mid April, assuming Covid cases begin declining. So far however, major stock indices in Europe and the US (outside of tech) have only pulled back 2% from all time record highs. As the US approaches 50% of population vaccinated in April, we feel Europe will then garner a huge increase in surplus vaccines that the US vaccine creators will be willing to share. Any Covid hiccups should be more an aberration to economic reopening, unlike last years series of false hopes.

It’s great to be king of the vaccines, grabbing a dominant share of production for domestic needs before sharing with others. Assuming the US and UK don’t have an alarming 4th wave as social contact barriers continue to fall, one would conclude that the US and UK vaccine success is a major reason why Covid is being contained in contrast with Europe and the rest of the world. This has allowed our economy to rebound faster and stronger. This has also supported an uptrend in the Dollar which should reduce high inflation fears, at least until Europe gets the green light to reopen and the Dollar rolls over.

In recent months we have talked about the parabolic phase of this Bull market in stocks morphing into a more labored Bull in the Spring after more than a year of non stop stimulus money and excess liquidity. The fears of higher interest rates will pop up each time interest rates surge to new highs. This will become more of a headline in the 2nd quarter as year over year inflation metrics surge to 28 year highs for a couple of quarters (2.5 to 3% core PCE). Yet we expect the broader stock market will continue upward in this early stage of economic recovery, although with ever deeper corrections and slowing upward momentum. The growing fears of a 3rd Covid wave in Europe and possible 4th wave in the US could also surface in coming days for a brief spike lower in stocks. However, Central Banks around the world will continue to support this market along with calls for even more Government fiscal stimulus should GDP growth expectations falter. Until Europe catches up to the US and UK in vaccinations and quells its latest Virus spike (April), then the Dollar can remain elevated and temporarily contain commodity inflation. Once Europe comes back out of its 3rd wave of Covid lockdowns, the Dollar can move lower once again, sending commodities like Copper to all time highs this summer. Any short term scare in stocks in March/April should present another buying opportunity for investors, perhaps even in the out of favor tech sector. The shift to increase exposure to small cap and cyclical last November, then mid cap in Q1, can shift again in the 2nd half of 2021 to a heavier Utility stock exposure in a more balanced portfolio as economic momentum and expectations peak.





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