Get our view on why markets are willing to shrug off political turmoil and a dark picture for payrolls
The riots in Capitol Hill and the storming of the Capitol building by disgruntled Trump supporters will no doubt be written into the history books of tomorrow, however financial markets shrugged the events off and viewed them not as a potential coup, as portrayed by the media, but rather as a mob on the rampage. Investors are instead showing signs of increased exuberance, the Dow Jones rose 1.6% in the first trading week of the new year and there were gains for European indices too, including the FTSE 100. In the US, stock markets are being led higher by economically sensitive sectors including banks and energy firms, this is happening at the same time that bond yields are rising. The yield on the US 10-year bond is currently 1.105%, the highest level since March. This means one thing: a reflation trade, which heralds an economic recovery that triggers rising incomes and corporate profits, and generally means a period of strength for equity markets. Thus, the good news for equity markets is not over yet.
What about payrolls?
But how can stocks rise even when the US employment picture is darkening? The 140k decline in Non-Farm payrolls last month was due to a plunge in leisure and hospitality employment, as bars and restaurants across the US were forced to close due to rapidly rising coronavirus infections. Interestingly, employment in other sectors rose strongly, which suggests that this decline in NFPs is solely down to lockdowns and thus may be temporary; thus the picture for US employment may not be darkening On the plus side, there was a 161k rise in professional and business service employment, 38k increase in manufacturing employment and a 120k gain in payrolls in the retail sector. This is all good news for the US economy. While jobs may continue to be lost in January, due to ongoing lockdowns and a sharp decrease in the numbers of people eating out at restaurants, the overall picture is stronger than NFPs suggest, and the household measure of employment, an alternative reading of the labour market, showed employment rising by 21k last month. This is still a weak rate of growth, but the unemployment rate remains steady at 6.7%, and the rate of permanent job losses has also edged down, suggesting that the damage to the economy from weak jobs growth will not be permanent and may not have the same economic effect as other recessions.
The future for stock markets: vaccinations and US fiscal stimulus
This is important for the narrative that stock markets will move higher and that sectors other than tech will start to see increased gains. If the US economy was experiencing an employment shock, with vast swathes of workers facing long term unemployment then the current stock market gains would not be sustainable. Instead, it looks as if the employment picture will pick up later in the year and that there is reason for optimism due to 1, mass coronavirus vaccinations that are now on the horizon, 2, further fiscal stimulus is expected now that the Democrats have control of the Senate, the House and the White House.
Can the Democrats deliver on fiscal stimulus?
Digging further into politics, the biggest risk now is that Trump does something deeply disturbing on the national security front in the time that he has left in the White House, 9 days. We don’t think that this is likely, the events of last Wednesday have already knocked his reputation, so the next few days could see him desperately try to claw back some respect at home and abroad. However, with Donald Trump you can’t rule anything out. However, we think that the biggest risk could be fiscal stimulus. Yes, the Democrats have control of all arms of power in the US, however, they only have control of the Senate by a narrow margin. They are still well short of a filibuster-proof 60 seats in the Senate. While they could try to implement large scale fiscal stimulus via budget reconciliation that is funded by tax increases, that process is only available once a year. If the Democrats were to enact large-scale fiscal stimulus they would have to win over some strictly centrist Democratic senators, who may not be inclined to see government debt levels rise above 100% to fund more stimulus. Thus, there is still a 50/50 chance that more fiscal stimulus is coming, but if Biden fails to enact more stimulus in his first 100 days in office, then we could see markets start to whinge. That is not a concern for this week, and we anticipate further gains for stocks in the next few days.
The main economic data to watch out for this week includes:
UK GDP, November 2020
The national lockdown in November is expected to have reduced GDP by 8%, to leave the UK economy approx. 14% below its pre-crisis level. While it is expected that GDP rebounded rapidly when the economy opened again in December, the latest, far stricter, lockdown will have caused that to reverse. We expect UK assets to shrug off the GDP figures, instead UK asset prices are likely to be sustained by the pace of vaccinations because the current lockdown will be only be eased once the government’s vaccination target has been met. Right now, the UK looks good on a global comparison level, but it needs to keep up the pace of vaccinations and improve it further. The restrictions on the economy will only be eased once the government is on track to meet its vaccination target of 13-15 million of the most vulnerable people and front-line workers. Thus, traders should keep a close eye on daily vaccination numbers as these could drive the FTSE 100 for the coming weeks.
US retail sales, December 2020
Retail sales are expected to fall slightly due to the hit to spending from the rapid spread of covid across the US. The biggest drag on spending is likely to come from spending on food and drink services. Spending on clothing and spending in department stores are also likely to have fallen sharply. Analysts expect a 1.1% decline in all retail sales, and a 0.9% decline in core retail sales. We think that the decline could be slightly less at 0.5%, which may give the dollar a boost. The dollar index had a better week last as it rallied alongside bond yields. If US Treasury yields continue to rise, then we expect the dollar to move higher in the coming weeks.
US consumer confidence, January 2021, Friday
Analysts expect a modest increase in consumer confidence for this month, however, we think that risks are skewed to the downside after the recent political turmoil in Washington. Unsurprisingly, Democratic voters are more confident than Republican voters, and have been for some months. We expect this split to continue; however, not even rising stock markets can protect consumer confidence from the events of last week.
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