For the first time since February 2020, Covid-19 is no longer the biggest fear among portfolio managers, polled by Bank of America, the bank said Tuesday.
The findings underscore how drastically the situation has changed over the past year. Confidence is growing with the introduction of vaccines, relaxation of health safety restrictions and unprecedented support from the federal government.
“Investor sentiment [is] unequivocally optimistic, ”Bank of America strategists wrote in Tuesday’s report.
US equities recovered quickly from the pandemic. The Dow hit a low of 18,592 on March 23. The index has since risen as much as 77%. The Nasdaq has doubled in that period.
Hottest economy in decades
Economists are also very optimistic, especially since Uncle Sam is supporting the economy a lot more than many thought it likely was a few months ago. Last week, Congress approved President Joe Biden’s US $ 1.9 trillion bailout package.
Nearly half (48%) of fund managers surveyed by Bank of America now expect a V-shaped recovery, against just 10% who predicted it in May 2020.
A record 91% of experienced investors expect a stronger economy, surpassing the confidence seen after Trump’s tax cuts were passed in late 2017 and during the early stages of the Great Recession’s recovery.
Inflation is very fearful. But are they exaggerated?
But all this optimism – on top of unprecedented stimulus from Congress and the Fed – is worrying some on Wall Street that the economy could overheat.
The big fear is that the revival in inflation will cause the Federal Reserve to hike interest rates quickly, shorting the economic recovery and the market boom. That happened in the 1970s and early 1980s, when the central bank led by Paul Volcker controlled inflation with aggressive rate hikes.
According to Bank of America, 93% of fund managers expect higher global inflation in the next 12 months. That’s more than 85% who said that in February.
However, US officials have pushed back against inflation fears. Over the weekend, Treasury Secretary Janet Yellen said inflation may rise, but only temporarily.
Ed Yardeni, president of investment consulting firm Yardeni Research, is not too concerned about runaway inflation, as about 10 million American workers are still unemployed as a result of the pandemic.
“A 1970s-style wage-price spiral is unlikely in our view, despite our government’s fiscal and monetary excesses,” Yardeni wrote in a note to clients on Tuesday.
The tipping point for bond yields
A related risk is a repeat of the taper tantrum in 2013, when government bond yields spiked after the Fed indicated it would gradually slow bond purchases as the economy recovered. Higher treasury rates could make stocks look less attractive by comparison.
After crashing to 0.3% last spring, the 10-year interest rate has recently risen to 1.6%. The spike in interest rates confused investors, causing US stocks to plummet before recovering.
So how high would yields have to rise to derail the bull market?
Bank of America said 2% of the 10-year Treasury could be “the level of settlement for stocks.” Nearly half of the fund managers surveyed said a 2% return would cause a 10% correction in stocks. Likewise, about half of investors said a 10-year Treasury rate of 2% or 2.5% would make bonds attractive relative to equities.
Still, professional investors don’t see a bubble, at least not yet. According to the Bank of America survey, only 15% of investors think the US stock market is in a bubble. A quarter say the stock market is in an early bull market, while 55% say it is in a late phase.