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Fed Remains Resolute in Bond Purchases and Yields

Posted by Trust and Investment Management Services Team on May 5, 2021 12:00:00 AM

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Most first-quarter corporate earnings reports have been meeting or beating expectations and this has raised the confidence that equity valuations are not excessive. The S&P 500 Index is trading at a reasonable 22x Price to Earnings multiple, but earnings estimates are being actively raised by analysts who see stronger revenue and profit growth in the second half of 2021. Financial, industrial, energy and basic materials companies are showing considerable revenue acceleration, expense control and order backlogs.
 
Earnings from Apple, Alphabet, Amazon, Facebook, Microsoft and Qualcomm were all above expectation and guidance was strong for the year ahead. Both growth and value stocks are rising, but the pervasive microchip shortage is constraining production at some cyclical companies like Caterpillar and Ford. Small Cap and Mid Cap stocks continue to lead the market, while the service sector, especially travel and leisure, is gradually recovering.
 
The U.S. Federal Reserve remains resolute in its bond purchases and bond yields, which were rising in March but have now trended lower. With the 10-Year U.S. Treasury bonds yielding 1.63% after rising to as much as 1.75% earlier this year, bond investors may be overly complacent. In the past 12 months, energy prices are up 65%, the Commodities Research Bureau Raw Materials Spot Index is up 39%, and the U.S. Treasury has injected $5.9 trillion in stimulus money into the economy. Inflation is expected to rise for the next few months, although the Federal Reserve has indicated it believes this will be transitory and temporary. 
 
The rise of national political noise has enticed certain CEOs of large companies to jump into the public conversation about voting rights, gun control, wage increases, union membership and climate change. The political polarization in Washington has empowered corporate leaders to take stands that otherwise would not be in their core responsibility or best interest. This adds to the risk of alienating some groups of their clients while pandering to another set. The trend seems to indicate that every organization is compelled to demonstrate political correctness. Many corporations are focused on highlighting environmental, social and governance issues through echoing government-desired policies.  This certainly challenges corporate CEO and board management with greater complexities and risks.
 
With GDP growing at 6.4% in the first quarter, the Biden Administration is pushing for even larger government spending. The “American Jobs Plan” and the “American Families Plan” are multi-trillion infrastructure and social spending programs designed to enhance assertive government economic management. With GDP growth exceeding expectations already, the need for more wasteful government spending and raising taxes will be debated through the summer. The Washington, D.C., think tanks and political spin doctors are placing low odds at the passage of these plans as they are presently written. These plans will likely be smaller and more targeted if they are passed and the tax hike proposals on capital gains, as well as on individuals and corporations will also be less onerous than announced. We will be monitoring this carefully over the next few months because it will add volatility to financial markets. 
  Index         Year-to-Date Return

S&P 500 Index 

11.3%

S&P Mid Cap 400 Index    18.2%
S&P Small Cap Index    21.8%
MSCI All World Cap Index     9.6%

 

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Topics: Market Update, Economy