A bright economic outlook and an extremely accommodating monetary policy created one of the longest and uninterrupted rallies in the history of the US stock market, but the risks associated with the variants of the coronavirus, a sudden change in monetary policy and high inflation raised concerns among some investors about a correction.
“Equities are going to take a big correction,” said Peter Cecchini, research director at Axonic Capital. “It won’t take much to overturn that basket of apples.”
Supported by strong investor inflows and record bond yields, the S&P 500, Nasdaq Composite Index and Dow Jones Industrial Average have risen an average of 35% since early November, shortly after the S&P 500 last fell more than 5% in a short period of time. But analysts said the market may soon be feeling the effects of surprisingly high inflation and the delta variant of the coronavirus, which could derail the post-pandemic recovery.
“Certainly, renewed closures and travel restrictions are an extreme risk, as is inflation that stays too high for too long,” said Matt Peron, research director at Janus Henderson Investors. “The market is rightly very focused on the duration of this inflationary push as the greatest risk to the business cycle, and therefore the market as a whole.”
The current stock run, which spanned more than 180 trading days, is one of the 15 longest periods in history where the market has not suffered a 5% correction, according to Goldman Sachs research . The longest stretch was 404 days, a race that ended in February 2018.
An increase in household net worth coupled with skyrocketing personal savings has drawn investors to stocks and a commitment by the Federal Reserve to keep rates close to zero and continue to buy $ 120 billion each month in bonds. prevented stocks from falling significantly, said Josh Jamner, an investment strategy analyst at ClearBridge Investments in New York City.
“Overall, the strong growth environment and supportive policy have supported the markets in recent months, and the dry powder from individuals and businesses appears to be rolling in recent periods of weak equity markets. “said Jamner.
U.S. household net worth jumped nearly 24% from the first quarter of 2020 to the first quarter of 2021, according to data from the Federal Reserve, while the personal savings rate stood at 12.4% in May, although above the average of 6.1% from 2000 to 2019, according to the latest data from the United States Bureau of Economic Analysis.
Households bought a net $ 172 billion in shares in the first quarter of 2021, the largest source of demand for shares, according to Goldman Sachs research. Households have allocated about 44% of their assets to equities, according to Goldman, which also forecasts up to $ 400 billion in net equity purchases by households in 2021.
In a July 23 memo, a team led by Goldman’s chief U.S. equities strategist David Kostin dismissed the potential impact of the delta variant on the stock market, saying it “shouldn’t pose a risk major market “.
“Vaccinations, household and corporate demand for equities and attractive relative valuations will support equity inflows and prices,” Kostin’s team wrote.
Fears of the economic effects of the delta variant, as well as rising inflation, have led to a surge in demand for government bonds.
The yield on 10-year inflation-protected Treasury bonds, also known as the “real return”, stood at -1.11% on July 26, a record high. Negative real yields imply a losing investment in the Treasury market given inflationary effects and were more common in Japanese and European bond markets before the pandemic than in the United States. The 10-year real yield has been in negative territory since March 2020. The yield, which moves inversely to prices, has fallen 54 basis points since its most recent high on March 19.
The benchmark 10-year yield stood at 1.29% on July 26, down 45 basis points from its March 19 high.
“This momentum is expected to weaken in the second half of the year as Treasury issuance picks up and potentially accelerates and Fed buying begins to slow, actions that could put upward pressure on nominal and real yields.” , Jamner said with ClearBridge.
Falling yields have been a boon for stocks, especially for “longer-lived growth stocks where valuation is very rate sensitive,” Peron said with Janus Henderson.
Markets are bracing for the impact of both the Fed’s accommodative monetary policy ending and the U.S. government’s fiscal policy, which has injected billions of dollars into the pandemic-stricken economy.
“The number one risk that will likely end up creating a major correction will be monetary and / or fiscal policy cliffs when trillions of both are not so readily available,” said Michael O’Rourke, chief strategist of markets at JonesTrading.