A deeper dive

Highlights of the Fed's "Economic Well-Being of U.S. Households in 2020" Report

Jacob Hess
May 24, 2021

The Fed recently released the results of one of its marquee surveys named "Economic Well-Being of US Households in 2020." The survey was conducted in mid to late November 2020 with over 18,000 individuals contacted to take the survey and a completion rate of 64.8%. This was the 8th year of the survey, conducted annually in the fourth quarter of each year since 2013. The results of the report provide an interesting look into the financial condition of the US population. This year's is especially interesting considering a pandemic had just ravaged the economy. Here are some highlights of how respondents described their current financial situation, income, and spending

Current Financial Situation

Recessions and economic shocks can be particularly damaging to an individual's economic well-being. One would expect the shock from the pandemic in 2020 to be especially damaging considering the unique circumstances. However, the very first glance suggests maybe not. At the end of 2020, 75% of respondents confirmed that they were "at least doing okay financially," unchanged from 2019. What's even more surprising is that the 75% also beats out the share "at least doing okay" in the years 2013-2017. There was some fluctuation within 2020 but not by much. In supplemental surveys, the April 2020 rate was 72% and the July 2020 was 77% both of which beat the years 2013-2016 and the latter being a series high.

What to make of this? More than anything, it suggests that the stimulus provided and the relief measures passed did enough to maintain at least a bare minimum of economic security during the pandemic which featured the highest level of unemployment ever. This and even the relatively high April number contradicts the sharp decline in consumer sentiment (down -28.9% from Feb 2020 to Apr 2020) and the stock market (the S&P 500 fell -16.7% from Feb 2020 to Apr 2020) which are notable sentiment indicators. A reason for this could be that respondents at the end of 2020 had hindsight bias. Looking back at one's initial financial condition at the onset of the pandemic has a different effect than assessing one's financial condition when uncertainty is at its highest.

The positivity about one's financial situation was stable across most demographics except for one. The cohort without any degree (no high school or college degree) saw a decline in "at least doing okay financially" from 54% in 2019 to 45% in 2020 (this was still above the cohort's positive response rate in 2014 of 42%). The only real decline was seen in less than a high school degree. This group is particularly sensitive in recessions. These workers have had significantly higher unemployment compared to the education level just above them, having just a high school degree, in both 2009 and 2020. Respondents with just a high school degree saw an increase in "at least doing okay financially" from 65% in 2019 to 67% in 2020 despite that group's unemployment up from 3.5% in Feb 2020 to 7.8% in Dec 2020.

Income and Spending

As mentioned before, the pandemic was closely related to a sharp increase in the unemployment rate from 3.5% in Feb 2020 to a peak of 14.8% in Apr 2020. From that, one would expect a significant decrease in households receiving income from wages, but data in the Fed's survey suggested otherwise. When asked to describe a respondent's family's sources of income (multiple income sources were allowed to be selected), 67% of respondents reported receiving "wages, salaries, or self-employment income" only a two percent decline from the 69% in 2019. One might expect a more significant increase in this answer in the context of a high unemployment rate that leads many individuals to report the need for unemployment insurance.

And many of those individuals received unemployment insurance. In the same question, 61% of respondents received non-labor income in 2020 well above the 54% who received it in 2019 driven by a 12% increase in the share of respondents who received unemployment income. It is very clear that the aim of policymakers was to get as much money in the hands of consumers as possible and not worry too much about direct stimulus efforts to the most impacted individuals. This frivolity is likely a consequence of the speed with which action was taken.

And in preventing uncertainty, these actions seem to have been effective. In a question asking respondents if their income was stable during the year, 71% of them responded affirmatively. This was the same as 2019 when there wasn't a global pandemic that forced individuals out of work. More importantly, only 11% reported volatility in income causing hardship. While families with less than $25,000 were most likely to report hardship from income volatility, a strong majority (58%) reported stable income and no hardships. The effect was largely different across industries, as one would expect with leisure and hospitality, construction, and natural resources/mining seeing the largest income volatility. However, a majority of workers in these industries still reported stable income month-to-month. Only 48% of respondents in the leisure and hospital industry reported volatile income despite the unemployment rate in that industry peaking just above 39%.

One possible explanation of the decrease in income volatility is an increase in income from "gigs" which typically increase with increases in unemployment. However, layoffs in 2020 were not paired with a significant rise in "gig activity," but in fact, it was the opposite. The Fed's survey found a -4% decrease in the share of respondents who earned money from gigs in 2020 compared to 2019. It also found that fewer people overall performed gig activities and even when they did, it accounted for less than half of an individual's total earnings. Based on these data points, it seems unlikely that the gig economy was a significant counter to the disruption in the traditional economy; instead, it seems that it saw its own disruptions from the pandemic.

Some interesting dynamics were also visible in monthly spending. Respondents who were more likely to report a drop in monthly income were also less likely to report a decrease in monthly spending. On the other hand, those who were more likely to report an increase in monthly income were more likely to report a decrease in monthly spending. The former trend was reported in cohorts with less education (Less than a high school degree) while the latter trend was reported in cohorts with more education (Bachelor's degree or more). It's a curious trend that is likely explained by how different groups used their stimulus checks. Specifically, it is consistent with a post from the Liberty Street Economics blog which pointed to higher income and more educated groups saving their first stimulus check more often and spending it on essentials less often than lower income and less educated groups.


The pandemic was a time of economic hardship for many, especially for groups of lower incomes. Despite these pockets of hardship, the overall economic well-being of US society seems to have held up in 2020 which contradicts trends in many economic indicators. Indeed, the economic indicator in 2020 seems to be the level of monetary and fiscal support which was highly effective in supporting households through unemployment and uncertainty. This will likely be one of many hindsight views of the pandemic that will paint this crisis as rosier than it seemed, and in the end, many may come to the conclusion that pure uncertainty was the most disruptive economic force for businesses and consumers. Pure uncertainty that was successfully combatted by the unwavering accommodative support from the Federal Reserve and unprecedented stimulus from Congress, both of which were shakier during the Great Recession following the financial crisis of 2008-2009.

The consequences of that unwavering support? That remains to be seen...

Relative Factors and Forward Change in Federal Funds Rate

Jacob Hess
May 16, 2021

The Federal funds rate is an interest rate set manually by the FOMC Governors and five Federal Reserve Bank presidents. The group of monetary policy leaders analyzes the economic situation in the United States using a variety of indicators to monitor the labor market, financial stability, consumers and business spending, and much more. They are guided by a mandate set to maintain price stability and achieve full employment. As one might guess, the unemployment rate and inflation are both tracked closely, but how directly does the current state of these indicators affect the change in policy rates?

In this analysis, the current rate of unemployment and inflation is compared to the last year of each data point to get a standardized score that is used to try and predict the 12-month forward change in policy rates. The unemployment rate (UR) is the standard headline rate cited by the Bureau of Labor Statistics, and the inflation rate (INF) is the annualized PCE Price Index from the Bureau of Economic Analysis. The policy rate is the Federal funds rate. The standardized scores are also calculated using the last 12-months for the unemployment rate and annualized inflation rate.

The Federal funds rate (FFR) has very different relationships with the UR and the INF. The correlation coefficient for a simple linear regression model of the relationship between the FFR and the UR is an insignificant R = 0.03 showing no clear connection between the level of joblessness and where policy rates are set. On the other hand, the correlation coefficient for the FFR and INF model is much more robust at R = 0.76 suggesting it is a much larger determinant in how the Fed chooses interest rates. This may not be entirely the case. However, developed economies have adopted lower policy interest rates as their economies have entered deflationary periods. There was also a period in the 1970s where the setting of the FFR was sensitive to high rates of inflation rate during the Paul Volcker's tenure as the chair of the Fed.

Because of the Fed's mandate, one would expect 12-month forward changes in policy rates to be guided by these two variables. A qualitative overview reveals that positive changes in the FFR are associated with a UR that is lower relative to the previous year while negative changes in the FFR are associated with a UR that is higher relative to the previous year. Using the same method, no clear connection is established between forward changes in the FFR and a standardized IR. This is antithetical to the linear regression results highlighted in the paragraph before.

The scope of the backward looking standardization of UR and INF and of the forward looking change of the FFR does appear to matter. The data is parsed using three different time frames: 12-months, 24-months, and 36-months, and it is observed that the shortest time frame for both variables produces the strongest correlation for UR while the effect of the scope is less apparent in the INF. This suggests that more recent rates of unemployment are used to determine if the current UR calls for a change in policy rates.

There are some outliers in the data. In particular, some high standardized URs in the 1970s are associated with positive 12-month changes in the FFR. The US economy in the 1970s is associated with some of the highest rates of inflation even when the economy was stagnate with high levels of joblessness. In 1974, inflation was running over 12% and unemployment rate was over 7%. Likely, the Fed's focus switched from a full focus on the UR to managing the stagflation that was limiting growth. In 1978, the Full Employment and Balanced Growth Act established more firmly the dual mandate of achieving "full employment and price stability." Regardless, it's important to understand that in some cases the UR takes a back seat to INF if price levels get out of control.

With the pandemic behind, the Fed has indicated that full employment has become the guiding factor of Federal fund rate increases over the next few years. In doing so, they have backed away from the inflation targeting at 2.0% to allow for inflation to run above 2.0% for some time. The model built in this analysis, which is heavily affected by the UR, predicts a 0.26% increase in the Federal funds rate in the 12-months after February 2021. The model suggests that the UR has reached a level relative to previous months' UR that warrants a slight increase in interest rates. Of course, the Fed's dot plot suggests this is not in the cards, but market expectations have already started to shift with higher inflation in the latest April release. Even if rate hikes do come sooner than expected, job gains will need to impress the FOMC, otherwise, the hikes will be few and far between.

Can Wage Growth Keep Up With Inflation?

Jacob Hess
May 06, 2021

Inflation is the buzz word of the time and one of the top concerns of investors and economists following the recovery from the COVID-19 pandemic. The most recent CPI and PPI releases for March have already hinted at elevated price levels being inflated by surging consumer optimism, falling infection rates in advanced economies, and successful vaccination pushes. Fed members have already confirmed that they are comfortable with inflation running past its former inflation target of 2.0%; Governor Michelle Bowman recently said so herself that "headline inflation measures will move above our [the Fed's] long-run target of 2.0%." That being said, it now should be fully expected that inflation is going to be a near-term reality.

Inflation in its most pure definition makes goods and services more expensive for consumers, a consequence that the Fed and managers of the economy may have to deal with for the next year (supply shortages in many markets could exacerbate these consequences). This could result in weaker consumption numbers if price levels get out of hand which would be a significant drag on consumption-reliant GDP growth. This is especially true if wages don't grow at a comparable level to prices.

From FRED, Continued Claims / All Employees, Total Nonfarm.

The wage issue has really taken a backseat since the pandemic began as restrictions forced mass furloughs and even permanent layoffs that lead to the need for increased unemployment benefits and direct stimulus payments from the government. The focus was correctly drawn away from wages to relief because it incentivized a proper public health response to the pandemic and because continued claims would rise to its highest level ever with respect to total unemployed (see chart above), and this does not include support from pandemic assistance programs which would put the peak claims-to-total employed ratio near 20%. But that focus should start to shift back towards wages as full employment is the target and government relief becomes less important once again. What has wage growth looked like since the pandemic began?

From FRED, YoY Growth, (blue) Average Hourly Earnings, (red) Employment Cost Index, (green) Gross Domestic Income, Compensation of Employees / All Employees, Total Nonfarm.

The few wage indicators for the US are the average hourly earnings (AHE) from the BLS, the employment cost index (ECI) from the BLS, and total compensation of employees from the BEA over the total amount of employees (also from the BLS). Two of these have grown significantly since the beginning of the pandemic, AHE and total-compensation-to-total-employees, while ECI has kept with its trend. It is worth noting that the BLS's ECI is calculating using a base long-term employment figure that may not encapsulate the increases in "temporarily absent workers." This may mean the true current ECI for the last three quarters should be higher.

True wage growth over the pandemic is probably closer to average hourly earnings which shot up to an 8.2% YoY gain in April and, since June 2020, have an average YoY gain of about 4.8%. This is similar to the total-compensation-to-total-employees indicator which peaked at an 8.2% YoY gain in Q2 2020 but instead of dipping, remained near an 8.0% YoY gain from Q3 2020 to Q1 2021. This is probably a result of health benefits being counted in compensation which were heavily used to cover the costs of COVID-19 to employees, so it's likely that paid wages as a component of gross domestic income trended more closely with AHE.

One thing is clear. Wage growth, which is known for being stubborn, broke trend in 2020 and for a good reason. Employees in many industries like hospitality, leisure, and retail were putting themselves at a higher risk of infection by staying employed therefore needing a sort of risk premium added to their wages. This came in the way of "hazard pay." The high wage trend was also a result of low wage earners being more likely to lose their jobs than high wage earners, a topic on which the White House recently published a note. Both these trends are likely "transitory," and their effects are exclusive characteristics of the pandemic economy.

From FRED, Job Openings.

Transitory. It's that word again. Can we count on wage growth to keep up with this new trend? Or is it destined to flatten out again? In a vacuum, growth would probably flatten, but there are many factors that could keep YoY wage gains higher in the near term. First, demand for labor in the US has already started to increase. Job openings in February 2021 were already 5.1% above February 2020 (which is considered pre-pandemic levels), and they are set to increase more when activity heightens in the summer. Finding labor at pre-pandemic prices is also likely to be more difficult with the enhanced unemployment assistance program not set to expire until August. On top of all this, minimum wage workers, the workers that have seen more layoffs during the pandemic, are hearing about a federal minimum wage hike to $15/hour which, if anything, has raised expectations of the type of wage they think they should have.

In the end, no matter how wage growth trends, it is likely to be overcome by inflation. In the scenario that low-wage earners come quickly back into the market at the low wages that they the market with, near-term inflation rising towards 3% will be felt. In another scenario where overall wages increase and keep with the pandemic growth trend, price levels rise even further as firms pass on the elevated costs of raw materials AND labor to the consumer. Suddenly, the excess savings from 2020 buys less goods and services in 2021. It will take successful management of this transition period from an economy that has been put on hold for almost a year to an economy that is seeing a rapid increase in demand to maintain a proper level of inflation so that developments in wage growth aren't harmful to either consumer OR firms.

All Eyes on Inflation

Jacob Hess
April 19, 2021

In the last two weeks, the Bureau of Labor Statistics (BLS) gave important updates on the price indexes, the Producer Price Index (PPI) and the Consumer Price Index (CPI) for the month of March. The releases are the latest insights into the fears of inflations that are on the minds of just about anyone participating in the economy. Both consumers and firms are ready to expand their spending (presuming the vaccination push is successful), and the anticipation of that expansion has already seen inflation expectations rise. The bond market has been the number one indicator of inflation expectations after an entire year of record low rates suppressed by monetary easing.


Treasury yields have been on the move over the last 6 months since November (around when the 2nd wave of the pandemic neared its worst). Near-term yields have remained muted as Biden's fiscal stimulus was passed, and the Federal Reserve continued to signal it would be dovish at least through the end of 2022 (hence the 1-year yield getting caught in the drop). The back end of the yield curve growth starts with the 2-year yield which has grown 14.3% which is modest compared to the 3-year yield, 5-year yield, and the 10-year yield which have run the most at 79.0%, 121.1%, and 80.7%. The market has clearly indicated where it sees inflation risks the most, over the next 3-5 years, and it even sees longer-term price growth higher than it did previously (30-year yield up 37.0%). Perhaps suggesting the extreme dovish footing of the Fed will be difficult to dislodge even in a boom.


The PPI release was first up with a monthly gain of 1.0% in March the 2nd highest since 2009 (the highest is two months ago in Jan 2021). The rise reflected rising input prices reported by firms in PMIs in early 2021 and supply shortages reported in various goods markets. Energy prices have been one of those rising input prices pushing PPI higher with three straight 5%+ monthly increases. While this category is ruled out of the often-cited core PPI, it's still a very real cost that firms deal with. Gas prices alone in March jumped 8.8% affecting any business that maintains vehicles. Besides energy prices (and food prices), core PPI grew 0.7% (also the 2nd highest reading since 2009).

Industrial materials saw some of the biggest gains. Machinery and vehicle wholesale prices grew 6.7%. Iron and steel prices grew 13.5%. Industrial chemicals prices grew 10.1%. Building materials continued their surge with a 10.5% increase in plywood prices (up 53.1% YoY), steel mill products grew 17.6%, and building paper and board grew 8.5%. These are just a few of many indexes that surged in March and are representative of the broad pressure being put on firms' margins at the moment. In the end, manufacturers have no choice but to press forward to resolve inventories unprepared for the surge in consumer spending.


The CPI release came in the next week keeping the inflation discussion on the table after strong PPI numbers caught the attention of many. The headline figure increased to 0.6% in March after an 0.4% jump in February. Most of the gains were energy-related with that index up 5.0% and core CPI up just 0.3%. The headline monthly gain of 0.6% doesn't seem like a large jump compared to historical data since 1947, about 1 standard deviation above the average of 0.28%. However, looking at more recent periods of muted inflation 2000-2021 and 2009-2021, the March gain is well above the mean + 1 standard deviation and just barely above the mean + 2 standard deviation respectively.

Some other monthly gains of note in the CPI:

  • Gasoline (all types) up 9.1% MoM.
  • Sporting goods down -1.3% MoM but up 4.8% YoY with restrictions relaxing.
  • Lodging away from home up 3.8% MoM but down -6.4% YoY.
  • Car and truck rentals up 11.7% MoM and up 31.2% YoY.
  • Airline fares only up 0.4% MoM and down -15.1% YoY. Might be an interesting index to track as a signal of consumers willing to spend.
  • Admissions (to events) up 2.6% MoM and down -4.0% YoY. Another possible signal of consumer hesitancy.

One question will continue to arise in inflation discussions: are the moves in inflation representative of a shift into a more inflationary period or will they be temporary and lead back to lower inflation? In a nominal sense, there is likely to be some sort of permanent shift to accepting more inflation in order to maintain what the Fed deems as "full employment." The FOMC has made this clear in the design of their new framework which indicates that they will look to "overshoot" the previous inflation target of 2.0%. Some might say that they've already done this successfully, after all, the headline CPI figure (including food and energy) was up 2.4% annually.

The caveat here is that the low PPI and CPI figures during the pandemic are distorting price data as numbers from the sharp reflation in 2021 are compared to the depressed 2020 numbers. TD Bank sees this statistical effect boosting YoY CPI at or above 3.0%. These numbers will stabilize in the latter part of 2021 and will give a better idea of what longer-term inflation might look like. The 30-year breakeven inflation rate based on the 30-year Treasury and TIPS read 2.23% at the beginning of April (before these releases) and seems like a sensible estimate of where things could be when the dust settles.

NOTE: Energy should not be ignored. The indexes measuring energy goods and services are often glossed over because they are exogenously determined and not considered in the statistics that the Fed uses to guide policy. However, they represent real costs that both producers and consumers will have to pay to consume things during an economic recovery. This is especially true for the summer where energy is used for fueling air conditioning, driving cars, flying planes, and much more. The more spenders have to spend on energy, the less they have to put towards sectors that have been suffering the most and are looking forward to savings turning into spending. Energy prices have cooled since they rose from about $36 in Nov 2020 to around $65 in March 2021, but demand in the summer (if not buoyed by supply) could cause them to heat up again. The effect this can have on dampening consumption is not negligible.

Views on Interest Rates and the Move in Treasury Yields

Jacob Hess
March 21, 2021

Treasury yields are front in center in March 2021 and look to continue to be in the spotlight through the end of the year. The steep rise comes at a point while interest rates are at the lowest they have ever been, so the description of these rates as "high" is relative to the near-term environment that they exist in. The most recent 5-year Treasury yield was 0.82% which is 45 bps higher than the beginning of the year (an increase of over 120%). However, that yield is well below the average yield from 1962 to now of 5.68% and below the average of 1.51% since 2010. There's been a lot of discussion about how yields will affect markets. Here are a few views from bank commentary from the last week.

A recent Morgan Stanley report compares the current situation to the "taper tantrum" in 2013 when markets reacted fearfully to the Federal Reserve's suggestion that quantitative easing might end sooner than expected. The Fed ultimately calmed the market's fears and sentiment improved. Morgan Stanley does not see that playing out here. Instead, they see rising Treasury yields in 2021 as "explained by a pricing-to-market phenomenon" and not as "impactful" on credit conditions or equities. Overall, they view the move as rooted in optimism and unlikely to "derail" the economy. On the other hand, risky assets might see some volatility.

That view was supported by FOMC members' projections for 2021 that were revealed after their March meeting. Their median inflation forecast increased from 1.8% to 2.4% suggesting that members may have underestimated overheating in prices and may have to consider controlling them in the near future. Despite the bond market believing in this possibility, Wells Fargo most recent weekly report does not align with that thinking as they see a Fed that is "in no rush to tighten" despite the increase in inflation forecasts and the improvement of GDP and unemployment forecasts. As a result, Wells Fargo sees near-term Treasury yields "at essentially 0%" while long-term yields respond to optimism and higher future growth by rising.

JPMorgan mirrors the belief that central banks will not tighten any time soon and thinks that policy rates won't be raised until "around the end of 2023." That's not for a lack of optimism. JPMorgan also thinks that there is a 90% chance of above-trend GDP growth in the US with a forecast of over 7% for 2021. They see that expected growth as pushing long-term yields higher while "the Fed controls the normalization of 10-year US Treasury yields toward a 0% real yield." This rise shouldn't cause volatility in financial conditions if it occurs "over the next few quarters."

Merrill Lynch's recent Capital Market Outlook continues to stress its view that the Federal Reserve is underestimating inflationary pressures and sees inflation above 2% happening sooner rather than later especially with huge government spending on deck via the stimulus bill. Similar to its peers, Merrill Lynch does not see the Fed moving against inflation anytime soon. Instead, they believe that the monetary policy will remain accommodative as long as the labor market has not acheived "full and inclusive employment." These factors will combine to result in a steepening of the yield curve.

Merrill goes a step further and says that the positive correlation between bonds and stocks seen so far this month is "unlikely to remain on a long-term basis." The flip from negative to positive correlation while Treasuries correct has happened twice before this decade, in 2013 and 2016-2018. In both instances, the positive correlation did not last long, and Merrill sees this as an indicator that volatility in markets will be short-lived. Summed up in a line, "We do not expect the recent move to be a regime change, but rather a likely and expected consequence of a small rate shock."

Commentary has been heavily focused on interest rates because of the large move. The consensus seems to be that, despite market yields increasing, the Fed is not interested in reacting to higher inflation prospects. Furthermore, the reports also insist that the move in yields is a healthy reaction to optimism and shouldn't worsen financial conditions if the rise is a gradual and not a shock. 

Inflation Indicators Healthy but Still on the Rise

Jacob Hess
March 17, 2021

The talk of the street right now is inflation whether it be Main Street or Wall Street. Chairman Jerome Powell made many references to it in his recent monetary policy testimonies in front of Congress just before Treasury yields began to move on Wall Street. That has sparked interest in the topic across the US as consumers and business owners begin to worry about rising costs. Google Trends shows inflation searches near a 5-year high after peaking in the first week of March.

Indicators are starting to show signs of inflation picking up as well with market expectations of inflation shifting as well. The movement is relative to near-term economic conditions as indicators continue to recover from a deflationary COVID-19 environment that has required central banks to overload the money supply to keep the economy afloat. However, concerns that a recovery could overheat into something more dangerous are rising especially with central banks doubling down on accommodative monetary policy. These assurances of low interest rates come despite a $1.9 trillion stimulus bill and many optimistic GDP estimates for the US and developed economies.

The following index is an attempt to measure how inflation indicators are moving relative to the last 4 years. The series are indexed against the 4-year median value (data starts in 2017) to represent their level compared to relatively normal conditions. The indicators are a few of many measures of prices and costs and were not selected for any particular reason other than that they are general measures of inflation and/or inflation expectations. Not every series has values for February and March (the most recent complete reading is January) so January values are used. The series are as follows:

The indicator has trended strongly upward since the pandemic began at almost a constant pace with most of the movement generated by PPI and the Fed PMI Prices Paid measures. This suggests that most of the cost inflation is at the firm level and hasn't come through to the consumers yet. This seems to be confirmed by CPI and PCE Price Index 2021 reported values reported below the 4-year median. The trend of low consumer prices relative to producer prices is not likely to persist if longer-term inflation expectations remain elevated. Nevertheless, the reflation that has occurred so far appears healthy and does not seem "too hot" compared to long-term trends.

The ideal path would be a deceleration of price growth in 2021 Q2 with that growth leveling out to flat in the second half of the year. However, that may not be possible with the current state of monetary policy, and the market is beginning to recognize that. The burning question is if the Fed and other central banks are willing to admit it as well. Once again, the stage is set for a battle over policy rate normalization as the pandemic finally passes.

Risky Assets Sell-off Despite Optimistic Economic Outlook

Jacob Hess
March 09, 2021

March has not been friendly to the stock market after an optimistic start to the year. Momentum from vaccinations was pushing investors forward with the expectations that the economy would snap back into recovery in 2021, but those expectations were paired with a strong rebound in Treasury rates which has spooked the market into fearing higher inflation and a Federal Reserve that will allow interest rates to rise in response. The Fed, however, has indicated that it plans to remain accommodative in the near term to support the quick recovery.

The moves in bond yields so far this year have been large and have lead to risk-off moments in equities. January was a relatively calm month with the 2-year Treasury yield flat, risk assets rising, the Nasdaq up 5.6% and the S&P 500 up 2.0%, and value stocks lagging, the Dow Jones Industrial Average flat. The stock market seemed to be following the trends of late 2020 trading. However, the trends broke with moves in yields. The 2-year yield rose 18.2% in February and 30.8% so far in March shooting off lows that had been established by highly accommodative monetary policy and deflationary forces from the pandemic. Over February and March, the Nasdaq has lost -5.9%, the S&P 500 about flat, and the DJIA up 5.3% as risky assets start to correct.

Trading has been representative of a trend of diverging performance between value and growth stocks since the pandemic began. Using the S&P 500 Growth ETF (SPYG) and the S&P Value ETF (SPYV) as representatives of these two classes of assets, one can see a longer-term trend of divergence from late April 2020 to March 2021. The correlation has spiked lower 3 times in the past year in periods of strong divergence. Even after those spikes, the relationship between growth and value remained choppy and struggled to surface above 0.80. So far in March, another correlation spike is developing with an 0.38 correlation coefficient in the first 8 days of trading.

Moving 30-day correlation between SPYG and SPYV.

Risk-off has not been the only theme of the sell-off. Investors seem to be rotating into sectors that haven't seen the joy that risky assets saw in 2020. The Energy and Financial sector, sectors that were negative in 2020, are both up strongly over the past month where Technology is hurting. Industrials and Basic Materials have also been solid over the past 30 days. Some of that is likely a result of inflationary pressures pushing up raw input material prices proving to be profitable for firms selling those inputs. Oil and gas prices, in particular, have gained steam leading to gains in the Energy sector.

Many will say that the correction was due, but that doesn't mean the volatility hasn't come at an awkward moment. The Federal Reserve has confirmed its strong commitment to accommodative monetary policy. The $1.9 trillion stimulus is on the verge of becoming law. GDP estimates for 2021 for advanced economies are some of the strongest in recent years. High rates of savings look to bolster consumption in the near-term as lockdowns ease. Everything points to a healthy environment for risk. However, that could also be the problem. An overheating economy leads to stronger cyclicality and an inevitable contraction. That could be a fearful catalyst because the Fed has indicated it intends to smooth out cyclicality as much as possible. If belief that central banks cannot do this diminishes, so will appetite for risk.

The Latest on Vaccinations and What it Means for Growth

Jacob Hess
March 01, 2021

The global economy remains on its back foot at the beginning of 2021 as vaccination deployment speeds towards its peak. Optimism among business leaders and in the stock market is firmly rooted in the success of vaccination distribution in order to begin the return to normalcy by the middle of the year. So far, four vaccines have been approved after reporting successful results with the latest Johnson & Johnson vaccine seeing approval on February 27th, 2021. As doses are rolled out and administered across the globe, everyone waits to see how the distribution of the limited supply develops.

Bloomberg's COVID-19 Tracker provides the most up-to-date data on vaccinations. As of March 1st, over 245 million doses of vaccines have been administered in 107 countries with over 76.9 million of those doses administered in the United States. In the US, daily vaccination rates average 1.8 million per day with some days seeing over 2.0 million per day. That translates to 1 or more dose for about 15.3% of the population. Dr. Anthony Fauci, the leading health figure in the US, says that the vaccination rate will have to reach 75 to 80% before normalcy can begin to return. Based on current rates, that would take about 7 months.

The rest of the world continues at a slower pace with about 6.8 million doses administered per day. Most of those vaccinations are being administered in China, the European Union, the United Kingdom, and India. Those four countries account for 65% of rest of the world vaccinations. The timeline at this rate would put a vaccination rate of 75% of the world population 4.5 years away. Of course, different countries will reach that level at different times. Israel, for example, has already fully vaccinated 37.6% of its population while much poorer African and Middle Eastern nations are still trying to secure a vaccine supply. However, in a heavily interconnected world, global herd immunity needs full vaccination coverage regardless of borders.

No one is more invested in global herd immunity than the largest economies which have suffered greatly from lockdowns, and therefore, the IMF G-20 nations monitor progress. The latest report suggests vaccines to be widely available in "G-20 advanced economies and several emerging market economies during 2021" but other areas might have to wait for 2022. Because of that, the IMF sees containment policies remaining in many economies outside of regions that have significant vaccine supply like the United States and the EU.

Advanced economies, like those of the G-20, and emerging economies (not including China and India) are expected to see a divergence in GDP growth. In the IMF's Jan 2021 World Economic Outlook see G-20 advanced economies growing at a low positive rate this year while non-G-20 emerging economies are projected to contract. These contraction forecasts are mostly expected in countries like Russia, Brazil, Mexico, and Argentina. The Latin America and Caribbean (LAC) and Middle East and Central Asia (MECA) regions are expected to see stronger contractions. China and India, large exceptions to the emerging economy rule, are among the highest projected GDP growers in 2021. Unsurprisingly, they are also in the top 5 in global vaccination rates.

The World Bank's reports have also pointed to this trend of doses per 100 people rising much faster than emerging economies. In fact, it cites the fact that "2/3rds of emerging markets and developing economies (EMDEs) and most low-income countries (LIC)" have not deployed any vaccine doses. As a result, EMDE investment is expected to lag the post-financial crisis rebound of 10.8% in 2010 at a projected 5.7% in 2021. History suggests that weak investment may "linger" as the World Bank has found that "losses to investment have been deeper and longer-lasting than GDP losses" after pandemics. Overall, it's a slightly less optimistic picture than what was imagined when vaccines were approved in late 2020.

Vaccines are the key to sentiment in 2021 that's why the data covering dose distribution will be heavily reported on. It may also drive financial markets this year. The outlook is still positive in most advanced economies, but the reality that vaccine availability in less developed regions of the world is weaker will soon set in. True normalcy can only be achieved in a massively interconnected world when those areas have been covered as widely as their richer neighbors.

Long Term Employment Shifts Caused by the Pandemic

Jacob Hess
February 23, 2021

The Bureau of Labor Statistics (BLS) is the top government department reporting on the labor market in the United States. As one might assume, it has been busy over the past year documenting the pandemic's devastating effects on employment. Since the crisis has slowed down, their research has moved from a focus on the short-term displacements of workers to a focus on how the pandemic could lead to larger shifts in long-term employment trends. The latest edition of the BLS's Monthly Labor Review dives deeper into changes to the Bureau of Labor Statistics 2019-29 employment projections.

The BLS looks at two different scenarios to update the employment projections model. The scenarios break down into "moderate impact" and "strong impact." In the words of the BLS:

  • The "strong impact" scenario assumes more widespread, permanent changes to consumer and firm behavior as a way to mitigate viral spread.
  • In the "moderate impact" scenario, increased telework is the primary force of economic change and has both direct and spillover effects. With more employees teleworking, the need for office space will decline, and so will nonresidential construction. Spending for employee trips to offices, including commuting costs, business travel, and lunchtime restaurant spending, are all lower here than in the baseline projections.

The most impacted industries in the short-term have been people-facing jobs in service and retail businesses that are deemed non-essential. BLS sees the pandemic's impact lasting beyond 2021 especially in retail and traveler accommodation. Both are projected to see stronger contractions in employment in the moderate or strong scenarios than original projections. Food services and drinking places are expected to see a larger drop-off with the baseline projection of 7.3% adjusted down to just 1.3% in the moderate scenario and -3.1% in the strong scenario. Employment trends are likely to be exacerbated by automation and e-commerce, in both retail (Amazon) and food service (DoorDash, Uber Eats), which will lead to less human interaction.

The rise of teleworking has been a paradigm shift brought on by the pandemic out of necessity. Businesses shifted from having the capability of incorporating teleworking to being forced to incorporate teleworking. As a result, the need to accommodate large-scale commuting of employees to and from places of work is likely to see limited growth. The air, transit, and ground transportation workforce is expected to see smaller growth in the moderate scenario, and in the strong scenario, is expected to be flat or see slight contraction.

An extension of teleworking and less commuting means less of a need for office space. As a result, the BLS sees a shake-up in the construction industry. Nonresidential construction employment is likely to decline in both scenarios despite an initial projection of a 4% plus growth rate. The effects might spill over into residential construction employment as lost workers cross over into that industry leading it to grow. Housing demand is also likely to increase with more teleworkers opting to move away from cities.

The industries that are expected to grow as a result of disruptions from the pandemic are mostly expected. Many of them are STEM-related and deal directly with the technologies that saw growth during the past year. First, employment in pharmaceutical research and similar medical research areas is projected to grow faster now as the pandemic has placed a new emphasis on public health. The successful techniques used to fast-track the vaccine have also lead to interest in those fields and optimism that they can solve other problems in medicine.

Computer systems and peripheral equipment manufacturing and design industries (growing quickly already) are expected to grow even more to supply the equipment necessary to support teleworking. The updated growth rates are huge up 19.1% for computer manufacturing and up 26.1% for computer design services, regardless of the moderate or strong impact scenarios.

With every crisis comes a paradigm shift and sometimes more than one. The COVID-19 pandemic is no different. The BLS report outlines major shifts that are likely to be "sticky" and how workforces will change because of those shifts. These workforce disruptions are more than just shifts in what kids will "want to be when they grow up" but instead representative of how firms and government will reallocate their capital to growing industries. Those new capital projects are the future of the economy and the market and what society will look like in the future.

Earnings Provide Positive Surprise Despite Pandemic

Jacob Hess
February 18, 2021

Earnings season is more than halfway over as companies continue to report on full-year financial results for 2020. Executives have been busy quantifying the effects of COVID-19 on business operations while looking to an optimistic 2021. Reports have come out for 74% of S&P 500 companies as of February 12th, 2020.

Results so far have been positive with FactSet reporting that 80% of companies beat EPS estimates and 78% beat revenues estimates. If that rate continues, it will be the 3rd highest rate of positive EPS surprises since 2008. Not only have there been more positives surprises, but they have come at a higher rate. The 15.1% average positive surprise margin has been well above the 5-year average of 6.3%. On an annual basis, S&P 500 earnings growth is expected to be at 2.9%. This would be the first positive rate since 2019 Q4 and the largest positive rate since 2018 Q4.

So far, the strongest sector has been communications services with firms in that sector reporting positive EPS and revenue surprises 95% of the time. Information technology, financials, and industrials have all been above average with EPS beat rates above 80%. Struggling sectors were real estate, energy, and utilities. Real estate and energy only saw positive EPS surprises 67% and 55% of the time respectively. Utility companies overall have reported revenue below estimates 86% of the time.

Based on forward estimates of earnings, the S&P 500's price-to-earnings ratio sits at 22.2x, slightly lower than the 22.4x reported at the end of 2020. The Forward P/E is well below the Historical P/E of 39.9x as analysts are expecting a huge recovery in earnings in 2021. In 2021 Q1 and 2021 Q2, earnings are expected to rise 21.2% and 49.4% respectively only to drop to growth between 10-20% in the last two quarters. For the full year, projected earnings growth is 23.6%. Based on this information, the S&P 500 index is expected to increase 11.4% over the next 12 months.

Forward P/E sits at 22.2x, slightly lower after positive earnings.

One thing that is driving positive earnings so far is a high net profit margin. At 10.9%, S&P 500 companies are reporting a net profit margin above the 5-year average of 10.5%. The boost in profitability is likely a result of stimulus money to businesses and consumers that is fueling huge jumps in consumption and retail sales. However, firms are also reporting increasing input prices with many measures of producer inflation rising (PMI "prices paid" measures, import-export prices, and PPI). This could put pressure on 2021 net profit margin if companies are not able to pass rising costs on to consumers.

Overall, full-year 2020 earnings have helped the argument for current equity prices. Broad-based positive surprises in both earnings and revenue have suggested that stimulus has been at least somewhat successful in reflating the economy. Expectations for 2021 are huge, though, and rely on vaccinations and stimulus to move in the right direction. One thing does seem certain... 2021 is going to be a better year than 2020 in many, many ways.