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April 07, 2021 at 04:20 PM
What You Need to Know
- As vaccine distribution and the effects of the stimulus progress, we should root for slightly higher inflation and higher rates.
- These conditions point to increased opportunity this year in economically sensitive cyclical stocks.
- Consider manufacturing, mining and chemicals, as well as consumer, auto, and companies that benefit from increased home buying.
We are entering the second quarter of 2021 on a relatively positive note: The latest round of stimulus is underway, vaccination progress is continuing, more businesses are reopening, and we are starting to see improvement in the employment situation. Additionally, the U.S. 10-year note yield has risen 87% since early January, a sign that the market believes the economy is recovering.
Notable investment themes right now are increased consumer spending, strength in the manufacturing sector and a focus on industries that will benefit from President Joe Biden’s proposed infrastructure package. As such, my equity portfolio remains 70% cyclicals, focusing on economically sensitive stocks with exposure to the economic recovery.
Interest Rates: Signs of a Normalizing Economy
Since starting January at below 1%, the U.S. 10-year Treasury yield is now at 1.727%. While this rise in rates may have shaken the market in Q1, it’s a sign that we are emerging from the crisis and the economic outlook is improving. When you consider that the economy shut down completely in March 2020 and take into account where we are today, the rise in interest rates is to be expected.
As vaccine distribution progresses and the fiscal stimulus continues to filter into the system, I believe we should actually be rooting for a little more inflation and higher rates. Markets can handle 2-2.5%, as long as rates are going up for the right reasons — namely, stimulus jolting the system.
I believe the U.S. 10-year note will hover from a 1.6% low to 1.75% on the high end — not dissimilar to where we were in early 2020, pre-pandemic.
The Infrastructure Boost
Biden’s proposed $2 trillion infrastructure package is aimed at creating jobs and providing further stimulus to the economy. While it will add to corporate tax rates, it will boost manufacturing industries, which constitute 12% of GDP. This doesn’t even include the sector’s multiplier effect on the broader economy: For every job created in industrial and manufacturing, 7.7 other jobs are created. An infrastructure package will clearly go a long way toward helping the nearly 10 million Americans who are still unemployed.
Biden proposes paying for the eight-year, $2 trillion infrastructure plan with 15 years of corporate taxes. While this is a concern, U.S. companies have done a remarkable job in terms of restructuring, reorganization and price increases and, in my view, can absorb higher taxes.
Another impact of higher corporate taxes will be a lower dollar over time, which will bolster U.S. multinational companies.
Economic Indicators to Watch
Signs of accelerating economic activity are evident in purchasing managers’ surveys. The Chicago Purchasing Managers Index (PMI) came in at 66.3 in March, the highest it’s been since July 2018. The Chicago prices paid index rose for a seventh straight month, touching its highest level since August 2018. IHS Markit’s U.S. Services PMI rose to 60 in March, up from 58.8 in February. This level represents the strongest expansion in the service sector since July 2014. Notably, the rate of input price inflation was the sharpest since data collection began in late 2009.
