Balance of risks to the upside, but don’t count on a smooth ride
US equities posted new highs, demonstrating some degree of adjustment to higher bond yields and some faith in central banks because short dated yields have remained contained. But investors should be cautious.
In the short term, the picture looks rosy. Earnings are expected to surge this year, vaccines are doing their job in slowing the rate of infections and liquidity is abundant. The VIX - a measure of volatility in the S&P 500 - has even dipped below 20 for the first time since the start of the pandemic.
However, the unprecedented level of fiscal spending from governments is not a fix without risks and central banks are trapped in a low rate regime for fear of triggering waves of defaults given the mountain of debt in the financial system. This is creating the potential for longer term excesses.
The vaccine is not a panacea either. Further mutations of Covid are almost certain and a number of countries are facing third waves of the virus. With less than 2.5% of the global population fully vaccinated, we can expect Covid to be with us for years not months.
As investors shift attention over time to other concerns - debt, inflation, fiscal imbalances, tensions with China - we expect bouts of choppiness. Overall, the balance of risks in the near term for equities is to the upside, but don’t count on a smooth ride.
