by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EST] | PDF

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Good morning and happy Monday!  The southern reaches of the middle of the country are finally seeing a thaw as temperatures moderate.  Equity futures are falling again this morning, mostly due to rising long-duration bond yields.  Although the rise in yields reflects an improving economy, there are concerns that the lift in rates will pressure multiples and depress equity prices.  We note that some of the index weakness is a function of pressure on the highest-flying names from the past year.  Over the past 12 months, the S&P ETF (SPY, USD, 390.03) is up 17.2% compared to the equal weight S&P ETF (RSP, USD, 135.60), which is up 15.3%.  However, over the past six months, the latter is outpacing the former, 24.1% to 15.1%.  This outperformance suggests rotation within the index; stocks that lagged during the downturn are playing “catch up.”  With the U.S. COVID-19 death toll approaching 500,000, we start today with pandemic news.  China news comes next.  A look at the U.S. economy follows along with political developments, and we close with an international news roundup.

 COVID-19:  The number of reported cases is 111,434,139 with 2,467,481 fatalities.  In the U.S., there are 28,134,803 confirmed cases with 498,901 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 75,204,965 doses of the vaccine have been distributed, with 63,090,634 doses injected.  The number receiving a first dose is 43,628,092, while the number of second doses, which would grant the highest level of immunity, is 18,865,319.

Virology

• Although we will likely cross the 500,000 fatality mark this week, trends are improving. New cases are falling rapidly.  Fatalities and hospitalizations, perhaps the best measure, are as well.  The steady increase in vaccinations, coupled with enough Americans who have survived an infection, is likely getting the U.S. closer to some degree of herd immunity.
• One of the questions surrounding the virus and vaccination is whether the latter grants sterilizing immunity or if it merely protects the recipient from infection. If the latter is true, vaccination is still important, but it does mean that a vaccinated person could be an asymptomatic carrier.  An Israeli study of the Pfizer (PFE, USD, 34.44) vaccine seems to indicate that it grants near sterilizing immunity by reducing virus transmission.
  • In Europe, health workers are rejecting the AstraZeneca (AZN, USD, 50.59) vaccine because of concerns that it is less effective than other vaccines.
  • Border restrictions in the EU have returned due to virus transmission concerns. Although the EU continues to hold the dream of creating conditions of a single state, the reality is that nationalism tends to return during periods of stress.
• Most researchers expect COVID-19 to become endemic over time. Much like influenza, it will be with us for good, but with vaccines and potential mutation to less virulent forms, it will not pose the same degree of disruption in future years.
• China led a massive disinformation campaign on COVID-19, blaming a U.S. bioweapons lab for the disease. Chinese pushed this prevarication through the web.  In reality, there is growing evidence that the virus not only started in China but was spreading undetected in Wuhan in November 2019.

China:  Washington and Beijing continue to circle warily; China admits fatalities regarding border clashes with India, and stirrings of democracy are seen with local government.

• Diplomats from both China and the U.S. have been making public statements recently. Today, Senior diplomat Wang Yi called for a “reset” in a speech.  What does that mean in practice?  The U.S. should lift sanctions and stop interfering in China’s internal affairs.  We have seen nothing to date that suggests the U.S. policy strategy towards China is changing.  Tactics are, as the Biden administration is courting allies, a change from the Trump administration.  The overall thrust of policy, which is curtailing China’s international ambitions, remains the same.
• China admitted that four soldiers died in various clashes on the India/China frontier.
• Beijing is trying to introduce a degree of local governance, creating homeowners’ associations. These bodies would be self-governing, deciding such issues as maintenance fees, superintendents, and other local matters.  The goal is to improve social stability.  However, the CPC wants to install its handpicked leaders for these groups.  Homeowners are rejecting these choices, creating a quandary for the CPC.  The party doesn’t want to get mired in these local disputes; conflict between property managers and homeowners is common, as their interests don’t coincide.  But, if homeowners get to pick their own association leaders, it looks like a democracy.

Economics:  Mortgages, the Midwest, and the British pound are in the news.

• The rise in long-duration Treasury yields is starting to lift mortgage rates. The average 30-year mortgage rate is now 2.99%, up nearly 20 bps over the past two weeks.  It is not unusual that buyers will rush to complete purchases when rates begin to rise, but eventually, the rise in rates will cool the housing market until home prices adjust lower.
• The Midwest labor market is showing signs of strength. First, the economy has seen a rise in goods consumption relative to services, and this area of the country is more dedicated to goods output.  Second, the relative lack of tourism in the region relative to the coasts means that fewer leisure and hospitality jobs have been lost.  Finally, working from home is apparently more manageable in the Midwest due to relatively inexpensive housing.
• The British pound took a dive after the Brexit vote and has remained depressed since then. However, now that Brexit is behind us, the GBP is beginning to make a comeback.  Our fair value, based on relative inflation, is in the $1.60 area, suggesting the currency has significant room to rally.

Politics:  It appears that the administration’s pick for OMB director may not be confirmed by the Senate.  Sen. Manchin (D-WV) has indicated he will not vote to confirm Neera Tanden.  She was a controversial choice, given her aggressive stances taken on social media, where she has been critical of senators.  This is the first Biden pick that has not had the full support of the Democratic caucus.  Although it is possible that a GOP vote could be found to save her nomination, the odds of her confirmation have lengthened considerably.

International news:  Iran, Myanmar, North Korea, the EU were in the news.

• Although Iran has been pushing for sanctions relief as a perquisite for talks with the U.S., it does appear Tehran is softening a bit. Iran had threatened to end or limit IAEA inspections.  In the end, Tehran has ended “snap” inspections by the IAEA but will allow for “satisfactory” oversight.  Although this outcome is better than a complete restriction of inspections, it isn’t clear that Tehran has moved enough to prompt the U.S. to reengage in talks.
• Since the recent coup, protests have continued in Myanmar. Over the weekend, security forces used deadly force against protestors, killing two and wounding at least 40 people.
• In our 2021 Geopolitical Outlook, we included North Korea as an item to watch. Reports suggest that the combination of sanctions and self-imposed border controls to prevent the spread of COVID-19 has led to a collapse in economic activity.  Kim Jong-un is reacting by cracking down on private market activity and trying to return to Stalinist economic policies of central control.  It is not unusual during periods of economic stress that North Korea engages in external threats to extract support from the rest of the world.  Given the current turmoil, we would not be surprised to see tensions rise in the coming weeks.
• The U.S. has not “named names” with regard to the Nord Stream II project, meaning that actual sanctions are less likely.  This second natural gas pipeline will make Europe increasingly dependent on Russian natural gas and deprive Ukraine of transit fees.  Previous administrations have opposed the pipeline, although none took aggressive enough steps to halt its progress.  Without new sanctions, it is more likely the pipeline will be completed.

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