Wall Street is pinning high hopes on mass coronavirus vaccinations to propel the U.S. economic growth story forward. Investors bet that the resumption in economic activities will pick up pace from the spring season that will bolster corporate earnings and, in turn, justify the lofty valuations in the stock market right now.

Global markets, and the ones in the United States, have recovered sharply from multi-year lows they hit during the onset of the COVID-19 pandemic, as central banks like the U.S. Federal Reserve swiftly slashed interest rates and infused liquidity into the system through asset-purchase schemes known as quantitative easing (QE).

With a new presidency under Joe Biden, Wall Street investors are also optimistic that the administration’s massive stimulus plans will boost the economy and lift sentiment, signalling their thumbs-up to the so-called Bidenomics.

Before analysing the U.S. market’s performance and its future prospects, here’s a look at a few trends witnessed in the markets lately

  • Stock markets are at all-time highs 
  • Companies are reporting very robust quarterly earnings
  • President Biden’s $1.9 trillion pandemic relief stimulus is priced in by markets
  • U.S. yield curve steepens to a four-year high. 
  • VIX Volatility index is suggesting strong market returns
  • U.S. Treasury Secretary Janet Yellen points to the country returning to full employment early next year. 

The Valuations Game 

While ‘The Buffett Indicator’ has hit a record high (see Figure 1), the current rally in the market and high valuations are likely a reflection of a low interest-rate scenario. The Fed has kept interest rates at historically low levels to tackle the pandemic’s economic impact. Interest rates are usually used as discount rates to value a company. So, lower interest rates technically imply higher valuations. 

Figure 1: The Buffett Indicator in 2021

Data as on February, 2021 | Source: Longtermtrends.net

U.S. Yield Curves Underline a Sustained Period of Economic Expansion

The yield curve has steepend to a four-year high (Figure 2), and a popular consensus is that the Fed will have to raise interest-rates to mitigate inflation, which is likely to cause the Buffett Indicator to converge to its long-term levels. As the economy then rebounds, the GDP will witness a rise and, as a result, moderate the markets’ valuations. 

Figure 2: US Yield Curves (upto 30-year US treasuries)

Data as on February, 2021| Source: US Department of Treasury

Market’s Stance on Biden’s $1.9-Trillion Stimulus Plan

Ever since assuming office, Biden and his administration has consistently pushed for the passage of a $1.9 trillion stimulus package. Experts at Brookings Institution estimate that this stimulus is likely to push the GDP above the pre-pandemic levels along with helping the government focus on providing financial aid to vulnerable households, tackle unemployment, housing debt and food insecurity (Figure 3). While the current GDP does not reflect future growth potential, if technology companies restructure or reshape the economy, this will be  a positive for Wall Street. 

Figure 3: Biden’s Stimulus Impact on Real GDP (2020-2023E)

Data as on February, 2021| Source: Brookings Institution

CBOE Volatility Index (VIX)  Suggests Strong Market Returns 

The Volatility Index or VIX , which measures the implied volatility in the S&P 500, is the most common barometer for investors to assess market sentiment. VIX and stocks usually move in opposite directions, but recent charts show an extreme event in this relationship —;  the VIX jumped a lot more than the fall in stocks. This trend, although a rare phenomenon historically, is usually seen during strong market advances and is typically a bullish signal for stocks.  The markets are continuously discounting strong future earnings and suggesting what we have been seeing: strong returns potential.

Figure 4: CBOE Volatility Index (VIX) Trends

Data as on February, 2021| Source: Fidelity Investments

Equities are Set to Stand Out 

Investors have enough reasons to look past the pandemic; there’s light at the end of the COVID-19 tunnel. Central banks are under no pressure to withdraw stimulus any time soon as normal life is set to resume. In the event that share prices do tumble, the Fed will ride to the rescue. Alternatively, the low interest-rate environment and the impact of QE on bond yields has made investing in equities most attractive to investors. Large institutions and banks that are currently weighing up the pros and cons among various asset classes are in favour of holding riskier assets with higher potential yields such as equities due to their best optimised returns potential in portfolios.

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