Markets Rally Highlights Bets on Recovery

 Markets Rally Highlights Bets on Recovery

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Electric-car maker Tesla is up 25% this year.

Electric-car maker Tesla is up 25% this year.

Photo: Qilai Shen/Bloomberg News

Investors are showing signs of increasing exuberance, reflecting optimism about a vaccine-fueled global recovery and the changed economics of the post-coronavirus world.

The Dow Jones Industrial Average rose 1.6% for the first week of 2021, marking its fourth-straight weekly gain despite a mob storming the U.S. Capitol Wednesday and a decline in nonfarm payrolls reported Friday.

The advance, which took the 30-stock index past 31000 in just 29 trading days, has been led by banks and energy firms. Bond yields have risen, taking the yield on the 10-year U.S. Treasury note to 1.105%, the highest since March.

When economically sensitive sectors and bond yields rise together, it often signals Wall Street is embarking on the classic reflation trade that anticipates a full-fledged economic recovery. It is important because it can herald rising incomes, stronger results at firms from retailing to manufacturing to technology, and further market gains.

But the blistering, stimulus-fueled rally over the past year may complicate that formula. While the case for economic recovery appears sound and many fund managers expect the market advance to continue, skeptics say stocks remain vulnerable to fallout from the pandemic, including still-high unemployment and questions about the pace of the vaccine rollout. Supercharged gains in assets from some favored stocks to cryptocurrencies to some commodities could turn out to be unsustainable.

That is likely a recipe for volatility as earnings season begins. The S&P 500’s 1.8% rise over the first week of the year pushed the benchmark above year-end price targets of firms including
Bank of America Corp.
, which has told clients to brace for muted returns after last year’s 16% advance.

“The stock market is already making the assumption we’ve crossed the bridge and are getting to the full reopening of the economy,” said Mike Wilson, a chief U.S. equity strategist at Morgan Stanley. “Things are getting stretched and one-sided now.”

Businesses at the center of the economy, such as banks and energy firms, are often among the earliest beneficiaries of an economic upturn.
Goldman Sachs Group Inc.
and
Exxon Mobil Corp.
are among the winners so far this year.

A more surprising big gainer: Used-car retailer
Carvana Co.
, up 16% this year, has risen more than 800% off last year’s lows, a market bright spot that few would have predicted.

Sales of used cars soared last year while purchases of new vehicles declined. Some of that buying was attributed to consumers using their stimulus checks, while auto dealerships had trouble getting new vehicles from the factory.

“A used car bought a year ago is worth more now,” said

Cole Smead,
a portfolio manager at Smead Capital Management.

Investor favorites of the stimulus era are also rising, in some cases at a pace that prompts traders to invoke past market manias. Electric-car maker
Tesla Inc.,
a presumed beneficiary of green-energy-related stimulus efforts favored by the Democrats who now control Congress, is up 25% this year. Tesla CEO
Elon Musk

is worth more than Exxon, thanks to the rally.

Bitcoin, the cryptocurrency that made its debut more than a decade ago as an alternative to fiat currencies distributed by governments and central banks, has risen 38% in 2021 to $40,132, more than doubling the high it set three years ago.

The risk buyers take on across the market right now “is unequivocally worse than eight or nine months ago because of price,” Mr. Wilson said.

The case for a robust recovery is widely held. Economists at Goldman this year raised their 2021 forecast for U.S. economic growth to 6.4%, reflecting in part expectations of a $750 billion fiscal stimulus in February or March. The World Bank’s estimate, which is closer to the Wall Street consensus, calls for growth of at least 3.5% this year.

Whenever the economy does fully reopen, it will look very different. Employment remains down by nearly 10 million compared with February of last year, and wage growth has been muted.

The bad news has been countered in part by the stimulus programs of the government and the Federal Reserve, an onslaught that with Democratic wins this month in the Senate has put investors on inflation watch. The 30-year Treasury yield has jumped by almost one-quarter of a percentage point since the start of the year to settle at 1.863% on Friday, its highest since March. When bond yields rise, prices fall and that means investors who own these bonds lose money, on paper at least.

While sub-2% long-bond yields hardly say inflation is at hand, price worries add to a challenging business climate.

Mario Gabelli,
chief executive of Gamco Investors, said investors should look at sectors of the consumer market that can withstand economic slowdowns.

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His flagship fund, Gabelli Asset Fund, has a stake in
Genuine Parts Co.
, an Atlanta-based distributor of replacement auto parts that has risen more than 6% over the last month. The company said last year that it was able to pass some costs tied to the U.S.-China trade war on to consumers.

“Inflation is like toothpaste: Once it gets out of the tube, it can’t get put back in,” said Mr. Gabelli, paraphrasing late German economist Karl Otto Pöhl. “So you see what companies can pass through rising prices.”

Many investors and analysts say conditions remain ripe for stocks to keep rising, at least outside some of the most crowded trades. The greatest threat to a roaring bull market typically is a Federal Reserve interest-rate increase, and that doesn’t appear likely for at least another year or two.

Another risk: the prospect that Congress won’t pass the stimulus bill Wall Street has come to expect. Friday’s rally cooled on reports questioning

U.S. Sen. Joe Manchin’s
(D., W.Va.) support for $2,000 checks.

Even so, many forecasters expect ultralow rates and economic improvement to mean more record closes ahead. Goldman Sachs predicts the S&P 500 will end 2021 at 4300, up 12% from Friday’s close, while
Wells Fargo
says the S&P 500 could climb 5%.

“We like equities,” said

Scott Wren,
senior global market strategist at the Wells Fargo Investment Institute.

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com