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First Quarter Outlook and Forecast

One year ago, GDP growth was expected to be 4.8%. Instead, it’s now projected for 2020 at -4%, the largest drop in modern history. Simultaneously, world stock markets increased in value from $80 trillion to $100 trillion even as S&P earnings per share dropped by 15% last year.

This strange stock market behavior can be explained by the sheer size of the stimulus thrown at the Covid-19 crisis. Essentially, the Fed threw $4.5 trillion at the $300 billion problem of lost Covid-19 wages. The enormity of this government stimulus overcame any economic downturn, uncertainty, or political tension. Another $1.9 trillion of stimulus was announced last week by president elect Biden. Two other factors that buoyed the market were low inflation and low interest rates. With a strong likelihood that short term interest rates will remain zero-bound through year end, and further Covid-19 stimulus likely, stocks should remain supported by unprecedented levels of fiscal and monetary stimulus.

There are many risks to signal for financial markets, although they remain mitigated by the liquidity mentioned above. Among them are:

• Alarming Covid-19 growth and a slow vaccine roll out.
• Rising inflation expectations
• Democratic corporate tax hikes to 28%
• An unexpectedly quick rise in interest rates (Low interest rates have justified high stock multiples for years. 10 year bond yields were at 0.5% in August 2020. They are now at 1.1%) Initial claims for unemployment are ticking back up and at their highest levels since August in the first week of January.

The biggest risk to the stock market right now is an unexpected “tapering“ of stimulus by the Fed. This is unlikely to happen, based on recent rhetoric by the Fed itself, but fears of inflationary pressures are building, and manifesting in commodity and materials prices.

The Fed’s policy mix has changed to focus more on direct transfers to households (stimulus checks) which is considered more inflationary than QE or a zero interest rate policy. Accordingly, bond yields are rising in anticipation of inflation. The new Democratic administration will inherit many bills to pay through bond
issuance, which will outpace the Federal Reserve’s QE bond purchases in Q1 of this year. Recently, the Fed has signaled that they see low inflation and a stagnant economy as a bigger risk than higher prices.

Because prices collapsed between March and May 2020 inflation will appear to be high this year due to comparisons made to last year. In some sectors inflation may even appear to be alarmingly high due to this base effect. These inflationary pressures are likely to prove temporary. After vaccination, consumers will want to binge after a sustained period of savings. When demand suddenly increases, but supply remains constant, higher prices may result until they reach equilibrium. Americans saved at double the normal rate in 2020 and that was before the most recent plans for stimulus checks of an additional $1400 per person in households with income of less than $75,000.

There are increasing signs of irrational exuberance in the stock market. For the first quarter however, we are likely to see Democrats spending even more in stimulus and infrastructure measures.

People working from home went from 12% of the working population to 37% in one year. This trend is likely to continue, albeit to the detriment of commercial real estate and REIT’s. With a Democratic administration, alternative energy, electric vehicles, and infrastructure stocks will receive continued interest. Energy may come back in favor in line with inflationary expectations. If President Biden increases either corporate taxes or capital gains taxes at some point, the oil and gas pipeline sector may also regain favor with its high tax advantaged distributions being protected. Technology and biotech should continue their bullish bias, while big Pharma may remain pressured by Democrats. In a “return to normal“, travel and leisure stocks may outperform. Cyber security has become a major theme for 2021 due to foreign incursions into government and corporate computer systems. Home improvement will continue to benefit from Covid-19 sheltering. Lastly, exporters will benefit from a lower dollar, whose decline will continue as long as the US government spending outpaces its tax receipts. A steepening bond yield curve may benefit banks, provided that credit defaults don’t begin surging in the second half. Some rotation from overpriced sectors like technology into more undervalued sectors may occur, as well as rotation from large cap stocks into smaller capitalized stocks as confidence rises in an economic recovery.
The Covid-19 pandemic should come to a close by the end of this year, when we can look forward to better times.

The Biden economic team has been well received by Wall Street so far, with Janet Yellen as the nomination for Treasury Secretary. The new administration is expected to renew stability in global trade, a positive for stock markets. Worth noting is Gary Gensler, nominated to head the SEC, whose current position involves teaching about cryptocurrency and block chain at MIT’s Sloan School of Management. Gensler is likely to carefully scrutinize bitcoin and possibly impose regulations on it.

Global Disclaimer
This report has been prepared by Metis Capital Management LLC. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst responsible for the preparation of this report may interact with trading desk personnel, sales personnel, other analysts, journalists, and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Metis Capital Management LLC is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Metis Capital Management LLC accepts no liability for any loss or damage arising out of the use of all or any part of this report. Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Metis believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

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