Speculative Activity Does Not Alter Outlook for Economic Recovery

This week, Wall Street generated plenty of headlines for the nightly news. The so-called “Reddit Squeeze” caused high levels of price volatility in a few select stocks. While noteworthy, we think this event is an isolated pocket of speculation that you see in asset classes from time to time, and nothing about it has changed our market outlook for 2021. Just as with the election and COVID-19, the broader markets are looking past short-term noise because the underlying economic data still looks good.

An already broadening economic recovery will be aided by the continued rollout of multiple COVID-19 vaccines. This will allow more businesses impacted by the pandemic to participate in the growing expansion. As a result, we should see further growth in an economy that is already exhibiting robust housing prices, businesses rebuilding low inventory and a healthy level of consumer savings.

While that broader story plays out, it is possible that financial markets may experience what appear to be more speculative swings in the near term. And when speculative activity runs high, it tends to bring back memories of euphoric times like 1999, when stock market gains evaporated with little warning. Keep in mind, not every asset class was swept up in the aftermath of the dot.com boom. International stocks and small-cap stocks, for example, performed well in the years that followed.

While it is prudent to exercise caution, we do not expect the recent spate of speculative volatility to spread widely throughout the broader investment landscape. For one, outside a couple of notable areas, valuations remain reasonable relative to growth expectations. In fact, many investors with a diversified portfolio and long-term investment strategy may not be experiencing a material shift in sentiment at all.

With that, let’s look to the broader economic headlines of the week.

WALL STREET WRAP

GDP Growth Looks Broad and Measured: On Thursday, the preliminary reading for Gross Domestic Product (GDP) showed that the U.S. economy grew at an annualized rate of 4 percent in the fourth quarter of 2020. Gains in fixed investment (including business and residential purchases) offset lower government spending in the final three months of the year. Personal consumption, which accounts for about two-thirds of the domestic economy, showed 2.5 percent growth in the quarter.

The report was a return to a normalized rate of economic expansion, following the previous two quarters, which had 30+ percent swings in both directions. This GDP figure clears the decks from 2020 and offers a solid base to grow upon in the new year.

Quarterly Earnings Surpass Expectations: Corporate profits are another sign that the U.S. economy is humming along at a steady pace. With more than one-third of the S&P 500 names reporting, 82 percent of firms have exceeded earnings expectations for the fourth quarter of 2020.

Overall profit is running 20 percent ahead of estimates at the beginning of the quarter, and the results are being confirmed by a wide range of industries. Following the financial sector earlier in the month, consumer, manufacturing and technology firms led the earnings parade this week. Overall, the market’s response to the results has been somewhat uneven, although some of that is due to volatility rippling from speculation in heavily shorted companies last week.

With another round of stimulus proposed by President Biden and the FOMC keeping interest rates near zero, these data validate our expectation for a broader economic recovery in 2021.

Two Potential Vaccines Show Efficacy: Both Novavax and Johnson & Johnson reported solid efficacy data for their COVID-19 vaccines this week. On Thursday, Novavax said that preliminary data showed its product was 89 percent effective in preventing spread of the disease during a Phase 3 trial conducted in the U.K. with 15,000 volunteers.

Johnson & Johnson posted results on Friday that demonstrated its own vaccine was 72 percent effective during a Phase 3 trial with more than 19,000 volunteers in the U.S. While less effective than the two vaccines already being administered in this country, the Johnson & Johnson product requires only one dose and can be stored in a standard refrigerator for three months.

It’s worth noting that the efficacy rates for both vaccines fell in smaller trials conducted in South Africa, where a new variant of the disease has been identified. Both Moderna and Pfizer, whose vaccines have already been approved by the FDA, confirmed this week they are working on a third “booster” shot to address potential COVID-19 mutations.

All of this positive momentum on the vaccine front means that business and travel restrictions should continue to be rolled back in the first half of 2021.

THE WEEK AHEAD

Key Indicator in ISM Data: The Institute of Supply Management (ISM) will report its January Manufacturing index later today, followed by the Services index Wednesday. In combination, these two readings offer the best real-time indicator for U.S. economic growth. Both have been running north of 50 since last June, signaling an expanding economy.

Jobs Report on Friday: The January employment report will be announced on Friday. While we view jobs as a lagging indicator in the current U.S. recovery, it would be a positive sign to start 2021 by adding net non-farm payrolls, following a negative reading in December.

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