US equity markets closed at record highs in the past week due to optimism about a large fiscal package and supportive monetary policy
US equity markets edged higher in the past week as the strong prospect of further fiscal stimulus and better-than-expected corporate earnings contributed to the upside. The S&P500 has been up in five out of the six past weeks (+1.9% wow ⅼ +2.3% YtD). President-elect Biden has proposed a new fiscal relief program of $1.9 trillion (9% of 2019 GDP).
The “American Rescue Plan”, will provide (i) direct support to households via “checks” of $1400; (ii) increased and extended unemployment insurance benefits ($300/week on top of regular benefits by additional 11 weeks); (iii) aid to small businesses and state and local governments and (iv) additional funds to the vaccination program against Covid-19. Having said that, the final size of the package could be trimmed to a lower, albeit significant figure in the tune of $1 trillion to $1.5 trillion.
The expected spending increases should be a large fiscal impetus to aggregate spending boosting real GDP growth and probably leaving the level of US GDP at the end of 2022 above the pre-pandemic path. The mean value of US 2021 real GDP expectations stands at 4%.
Corporate earnings are expected to edge higher in tandem, with heightened expectations for a cyclical recovery following a sizeable decline in Q2/Q3 of 2020 (see graph page 3). The US Q4:2020 earnings season has begun on a strong footing. The mean positive surprise per company hovers at 22% vs a 5-year average of 6%.
Out of 12% of the S&P500 companies that have reported so far, 86% have exceeded estimates vs a 5-year average of 74%, while analysts’ expectations for EPS growth in Q4:20 stand at -5.2% yoy from -9.4% yoy at the start of the season and-5.7% yoy in Q3:20. Looking forward, analysts expect EPS to improve substantially in the course of the year recording double-digit increases.
Euro area equity markets lagged due to escalating Covid-19 cases and extending lockdowns (Germany) with the Eurostoxx index flat on weekly basis. Political uncertainty (Italian Prime Minister Conte has eventually resigned) and a slight hawkish addition by the European Central Bank to its monetary policy statement weigh negatively as well. Indeed, the ECB added that the total envelope of €1,850 bn of the Pandemic Emergency Purchase Programme (€781 bn as of January 15th) may not be used in full if favourable financing conditions can be maintained with asset purchase flows that do not exhaust the PEPP envelope, driving the euro area periphery bond spreads higher.
Nevertheless, as Chair Powell has stated, now is not the time to talk about exit from the path of asset purchases. The Federal Reserve (Fed) convenes this week (January 26th – 27th), albeit we do not expect any change to the forward guidance. US Treasury purchases will continue with a pace of at least $80 billion per month and of agency Mortgage-Backed Securities by at least $40 billion per month. The US economy is far from the Fed’s goals of maximum employment and average inflation of 2%.