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Second Quarter Forecast and Opinion

The US savings rate is very elevated at 13.6%, compared with a pre-Covid average of 6% since 2000. Americans have been saving during the pandemic at an unprecedented rate; as the pandemic abates, they will begin spending with pent up demand. This, combined with a rapidly recovering economy, an unprecedented increase in money supply, a Federal Reserve which seems committed to unlimited economic stimulus, ever expanding fiscal stimulus from the government, and a new sense of optimism about a successful vaccination program are keeping spirits high in the stock market.

The Fed has repeatedly committed to keeping the overnight Fed funds rate low, and there has been an unprecedented increase in the supply of money. In the first quarter, the bond market reacted badly to this. Anticipating inflation, 10 year bond yields jumped by more than 3/4 of a percent. Fears of inflation were exacerbated by a boost in commodity prices. A severe drought in China has boosted grain prices, and demand for copper from China sent its prices soaring. Lumber prices have risen 140% in the last year due to the pandemic induced housing boom and Trump-era tariffs on Canadian lumber. However worries about inflation at this point seem a bit over-done. There are still deflationary pressures in the system with unemployment rates at 6% and salaries under pressure, which is why inflation should remain relatively low through year end, despite the strong rebound in the economy. “Real“ interest rates, or interest rates minus the current level of inflation (1.7%) are still negative. When investors anticipate inflation, as they do now, and they believe cash investments will continue to yield them zero, they are encouraged to invest in stocks. If and when the inflation rate goes higher than the Feds target of 2%, the Fed might consider raising short term interest rates. But there is very little probability that this will happen in 2021. It may even be argued that Fed Chairman Powell is among the most “dovish” that has ever held the office.

Furthermore, earnings for S&P companies are expected to rise by 6% in Q1 2021, having been revised downward too aggressively due to the Covid recession. The energy and materials sectors are expected to post double digit earnings growth. Meanwhile, the VIX, or “fear index“ is resetting lower, to pre-Covid levels, and looks as if it’s heading even lower which is bullish for stocks.

The reopening trade underway should benefit banks, industrials, and basic materials. In the latter case, the Biden infrastructure bill will provide tailwinds.

In the technology space, there is a massive shortage in semiconductors. Emerging Industries such as electric in autonomous vehicles, or ramping demand for semiconductor chips, as carmakers and cell phone manufacturers are now facing shortages. Cryptocurrency mining is also contributing to increasing demand for graphics and a video processors. As demand is now outstripping supply, chip manufacturers as well as companies that build machines to make chips, will continue to benefit.

The early part of the first quarter was notable for record inflows into new technologies: Electric vehicles, autonomous vehicles, solar power, genomics, and financial technologies based on cryptocurrencies. A sense of market froth manifested itself in a frenzy of SPAC activity which totaled $26 billion of share sales in blank-check companies in January alone. Alternative currencies, despite being imaginary, unregulated, and leveraged, hit all-time highs as Bitcoin reached levels of $60,000 per coin. If this sounds like a bubble, it is no doubt driven by the sheer amount of money in the US financial system, which shows no sign of slowing. It should be noted that the new SEC Chief Gary Gensler was professor of cryptocurrencies at MIT’s Sloan School of Management prior to this role, leading some to speculate that regulation may be ahead for cryptocurrencies, which in part facilitate crime and tax evasion.

Traditionally, April is a month that is kind to the stock market. Over the past 20 years, the S&P 500 and the Dow Industrial index have averaged a 2.5% return, and the Nasdaq a 2.8% return. Interestingly, world indices have averaged no gains over May and June for the same period, and the S&P and Dow Industrials have tended to be negative for that period.

The S&P 500 index was up 5.77% in the first quarter, the Nasdaq gained 2.7% and the Dow Industrial Index gained 7.76%.

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