Economic Update: January 2021

SUMMARY

Most of us were anxious to see the end of 2020 with desires of a return to normality in 2021; however, January has continued in a similar light with much for market participants to navigate already. The Democrats ended up winning both seats in the Georgia run-off election, resulting in an even split of 50-50 between Democrats and Republicans in the Senate. Protests at the US Capitol left five people dead, and as a result, the House voted to impeach outgoing President Trump, setting the stage for a trial in the Senate during the first days the new administration. Georgia's results and hopes for a substantive fiscal stimulus package after Inauguration Day kept upward pressure on US Treasury yields and buoyed asset valuations.

The COVID-19 vaccine rollout began slower than expected but has since improved. The US now accounts for over 1 million of the approximate 4 million vaccines administered every day around the world. Deaths in the US related to the virus seemed to have peaked in the first part of January and have since declined.

The recent FOMC meeting saw the Fed's chair, Jerome Powell say he does not see interest rates rising any time soon and that the committee would like to let inflation run above 2% for some time. He also noted the recent optimism in markets primarily due to the vaccine and fiscal stimulus as the main driver for higher asset prices, not the Fed's monetary policy.

Equity Market Index Performance

US equity markets posted gains for most of January, with the major indices hitting fresh all-time highs in the last week of the month. Still, volatility quickly returned in the final days, reportedly driven by retail investors activity in heavily shorted stocks. This so-called 'Reddit movement' promptly gained momentum, reportedly causing heavy losses in some hedge funds and helped drive record volumes across most US exchanges. The trading activity caused growing concerns from both Congress and US regulators with much still to play out.

The Russell 2000 (+5.2%) and Russell Microcap (+14.1%) indices were the top performers in January, with both now over +100% above their March 2020 lows. The blue-chip names in the Dow Industrials lagged (-2%) as did large caps in the S&P 500 (-1%) with both Growth and Value finishing the month in the red. The Energy sector continued the charge higher (+3.9%) leading all other sectors, with Healthcare (+1.5%), REITs (+0.7%) and Discretionary (+0.5%). Consumer Staples and Industrials declined on the month.

Treasuries, Commodities and the US Dollar

Market participants noted significant developments in the rates complex during the month on January, with the US 10y and 30y US Treasury yields breaking out of a 7-month trading range. The 10y yield ended at 1.07% gaining 15bps, and the 30y ended at 1.83% gaining 18bps. 10y US Treasury breakevens ended at 2.10% rising 12bps.

WTI ended the month on a firm footing rising +7.5% to close at $52.30 per barrel. Copper was up +1.2% and has been positive nine out of the last ten months. Precious metals were mixed in January with Gold down -2.7%, but Silver rising +2.3%. In digital assets, Bitcoin posted a relatively modest gain of +19.8%, the smallest monthly appreciation since September 2020.

The US Dollar Index (DXY) has been on the back foot for most of the last 12 months but saw a slight gain in January of +0.7%, but the trend lower still seems firmly in place for now. The DXY came close to its 2018 lows which is an expected support level in the index. Equity markets are potentially close to some corrective price action which could see a flight to safety and appreciation in the USD and US Treasuries.

US earnings season is now well underway with around 40% of S&P 500 companies having reported already. Over 80% of the companies to report have beaten EPS which is higher vs the five year average of 75% beating estimates. Earnings are above the five year average of 6.4% currently at 13.5% above consensus and sales are also higher with 75% of companies surprising to the upside compared to the five year average of 61%. Forward twelve month PE for the S&P 500 is currently at 21.8, which is above the five and ten-year averages of 17.5 and 15.9.

Australian Markets

The ASX200 posted a modest gain in January +0.3%, with Consumer Discretionary (+4.8), Communications (+2.8%) and Financials (+2.3%) leading the way. Real Estate (-4.4%), Industrials (-3.1%) and Health Care (-1.8%) sectors all lagged during the month.

Earnings season has begun with investors eager to understand how quickly corporate earnings are likely to return to pre-COVID 19 levels. Earnings upgrades in the materials and resources sectors have lifted expectations in financials on the back of an improving economic outlook in Australia.

The AUD/USD has been one of the primary beneficiaries of the risk-on tone in equity markets since the lows seen in March 2020. The AUD peaked in January at $0.7780 vs the USD and has since consolidated the strong gains seen in the past few months. The AUD/USD fell -0.6% in the month helped by the RBA's continuous dovish policy and low-interest rate settings.

House prices in Australia continued to rise in January showing a modest +0.7% gain nationally vs the previous month, but forward-looking indicators like home loan applications have increased +60% since May 2020 and risen +31.3% vs the previous year to December 2020, which is the fastest pace since 2009.

The labour market was another shining light in the local economy, adding another +50,000 jobs with the unemployment rate dipping to 6.6%. Market observers expect the rate of new employment to decrease in the coming months as it will be easier to increase hours of existing employees, rather than employing new workers.

CPI for Q4 2020 came in a little hotter than expected at +0.9% vs the previous quarter, which was due primarily to one-off changes in tobacco excise and child care costs. The core CPI figures were a more subdued at +0.4% on the quarter but still welcome news to the RBA which has struggled to shift the inflation needle in recent months.

The Months Ahead

The increase in volatility and the decline US equity indices seen in the last week of the month was relatively modest by current standards with the major indices only down around -4% from their 52-week highs and following substantial double-digits gains over the past five months. Still, while the Nasdaq 100 and S&P 500 were touching all-time highs, divergence in breadth and momentum began to appear. Many companies are now trading below their 50-day moving average and trending lower, after peaking at the beginning of January. Some market technicians note a bearish reversal pattern in US indices on the weekly timeframe, which could mean a correction is in the works.

Looking at the bigger picture, the decisive price action in recent months shows that investors are optimistic about the year ahead. The vaccine rollout is improving, and corporates are beating EPS and revenue expectations. The Fed stands ready to act. Congress is in the final stages of passing a substantial fiscal stimulus package that is expected to be around $1.9T, following the $900B seen in December 2020. In the short-term, equities could be in the early part of an overdue correction, indicated by many of the companies who have beaten expectations have traded lower following. The USD could potentially see an uptick in this scenario and is currently showing a bullish divergence.