'Can't we just enjoy it?'
A bear's gonna worry but the underlying story still bullish.
Another week, another worry. President Biden’s proposal Thursday to nearly double the capital gains tax kneecapped a market that had been rallying. It was the latest in a litany of problems bearish market participants see. There’s higher inflation and interest rates, of course—though neither really have broken out yet, with longer rates well off this year’s highs. Tougher seasonality—though the “Sell in May and go away” adage doesn’t really hold up as headwinds typically don’t really pick up a fuss until mid-July. Valuations—at 22.4x, the S&P 500’s forward P/E multiple is nearly 2 standard deviations above “normal,’’ and all 11 of its sectors are trading above their 10-year averages. Sentiment—investors buying the S&P when ISM manufacturing registers above 60 (it was almost 65 in March) historically have experienced flat to paltry returns a month to a year out. Meanwhile, TIS Group is worried that the Fed is trying too hard to rationalize its new regime. Indeed, the Fed has shifted from consistent concern about disinflation to reassuring the public actual inflation won’t be sustained, with everything framed in terms of one-time occurrences—the blockage of the Suez Canal and subsequent shipping delays; the rise in suburban house prices as Covid changed buyer preferences; the computer chip shortage that caused some auto plants to close; supply shortages in lumber, materials and even workers as vendors and establishments got caught unprepared for recovery’s rapidity. Please, where is the Margaritaville crowd?
The next six months are unlikely to disappoint. Ever-rising consensus now expects the best GDP growth in generations and a stunning 38% year-over-year (y/y) increase in first-quarter earnings once all the reports come in. Surely, this is already priced in, no? And now, a quick shift in the reopening narrative, from “growth is accelerating” to “normalization is a long way off,’’ has contributed to the sharp underperformance of Value relative to Growth over the past several weeks. The market appears to be fixated on vaccinations that haven’t occurred, and on the parts of the world where Covid-19 trends are worsening, most notably India (which accounts for 30% of the recent surge) and Brazil but also Turkey, Argentina and Japan. France and Germany’s numbers remain elevated, as do some regions of the U.S. such as Michigan, which is facing a new surge. Temporary! The spread between 12-month forward P/Es for Value versus Growth names has fallen back to its 4th percentile, where it stood early in the pandemic when the outlook was far more opaque. This softening of reopening names (small caps, cyclical value) that had such a strong run since early fall is enough to raise Strategas Research’s guard for the first time in a year. It thinks the collision of “peak data” and “peak breadth” versus the backdrop of big expectations and full positioning is at play. As a discounting mechanism, the market always looks six to 12 months out, and may be wondering if this spring and summer is as a good as it may get for GDP and earnings growth, however spectacular each may be.
Credit markets seem unconcerned at this stage. The yield curve has flattened the past few weeks, which suggests the biggest market hurdle ahead may be lofty expectations and crowded positioning as opposed to a more sinister surprise. What the “peak” argument misses is how quickly the labor market is recovering (more below). It is well ahead—by years, actually—of the post-global-financial crisis experience, and the output gap is closing rapidly. Also, real yields were positive back then; today, they’re still solidly negative. Housing was dormant then, it’s booming now. And savings were low; they’re near record highs now, with household net worth at a record high. Layered over this: the loosest aggregate policy setting on record, with fiscal stimulus that seems to know no bounds (Biden appears intent on being this century’s FDR) and an economy and market that are, by historical standards, still in the earlier stages of their cycles. In the past, the S&P has peaked when earnings peaked, which appears likely to be years from now. Perhaps you’ve seen me on Fox Business or Bloomberg Television from time to time, the camera loves me. Now, about two years ago, CNBC’s Joe Kernen and Becky Quick had me on, worried that the market was too expensive. Just as today, though, bullish expectations were being surpassed. My quip to them, “Investors see long-term buy-and-hold secular bull markets maybe three times in their lives—first and third, too young (no money) or too old (about to die). Here we are in the middle one. Can’t we just enjoy it?” Becky chuckled … and here we are again.
- Surpassing expectations Markit's initial read on April topped consensus, as records in manufacturing and services components pushed the composite PMI to a new high. Unlike slippage in existing homes (more below), new home sales snapped back sharply in March, exceeding expectations. Elsewhere,weekly jobless claims dramatically and unexpectedly fell again to a new recovery low, and Conference Board leading indicators rose above forecasts.
- Surpassing expectations About a quarter of way through the Q1 reporting season, earnings have been strong, with the percent of companies beating consensus revenue forecasts tracking at a new all-time high (86%) and the percent of companies beating consensus on earnings-per-share (81%) just short of all-time highs, with beats averaging 24%. Indeed, in the last three quarters, earnings went on to beat by another 10% before the season is over.
- Surpassing expectations Reflecting a broadening recovery, Philly Fed State Coincident Indexes increased in 49 states in March. Also, Architecture Billings jumped to almost a 14-year high, with project inquiries at their highest level since August 1999, boding well for capital expenditures as non-residential structures account for a fifth of capex.
- Hard to buy what you can’t find March existing home sales unexpectedly fell, and while the y/y trend remains solid, two headwinds remain: higher prices (the median price jumped 18.4% y/y) and most notably, the lack of supply (inventories for sale held at record lows). A third wrinkle eased as the 30-year mortgage rate fell back below 3%.
- Hard to hire those you can’t find A record 42% of business owners surveyed by the National Federation of Independent Business said they had job openings that they couldn’t fill. A McDonald’s franchiser in Florida is paying people $50 just to show up for a job interview.
- Pressure at the margins While top-line forecasts are likely to still show positive surprises, the y/y pressure on margins is set to be the worst on record, Jefferies believes, largely due to some of the sharpest y/y increases in transport, commodities & raw materials and gasoline prices in modern history.
Wage inflation is unlikely Researcher Redburn notes that tech disruption has been hollowing out the jobs market for decades, raising the return of workers whose skills are complementary with new technologies and lowering the return of workers whose skills are substitutable with those technologies. This process helps to explain the weakening of the “Phillips curve” unemployment-inflation rate relationship and why wage inflation has failed to reignite despite lower and lower jobless rates.
Wage inflation is really unlikely If anything, the Covid crisis intensified tech’s deflationary impact by accelerating the adoption of digitalized ways of working. It’s tempting to think in terms of “cost-push” inflation, i.e., rising costs get passed on to consumers, who then push for pay increases. But today’s reality may be better described as “efficiency-pull” deflation as companies seeking to remain competitive can’t fully pass on higher costs so they deploy new technologies to boost productivity.
Runaway inflation—nope In speeches, central bankers put the unmeasured impact of rapid technological changes on inflation, GDP growth and investment the past decade in the range of 10s of basis points. New research from respected Philly Fed economist Leonard Nakamura says it’s more like 100s of basis points per year—significant “tech deflation” that argues against a sustained inflationary boom even if nominal growth takes off as expected.