Everything rallies Everything rallies http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\race-finish-line-small.jpg August 13 2021 August 13 2021

Everything rallies

If everyone expects a pullback, maybe it doesn't come.

Published August 13 2021
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Everyone is talking about peak growth off last year’s worst pandemic quarter (so what) and whether investors should be cautious. But there’s an awful lot of liquidity in the market—the Fed’s broad gauge of money supply set a record in June—and it keeps looking for a home. Everyone’s expecting at least a 5% pullback (which hasn’t occurred for 10 months), and they continue to be disappointed. Analysts can’t keep up with corporate earnings. Q2 was another blowout—with 90% of S&P 500 constituents having reported, aggregate earnings were up 99% year-over-year (y/y). So, even though the market keeps setting new highs, valuations have barely budged. The forward P/E has hovered around 21x for a year. That’s elevated on an historical basis but reasonable given low interest rates (for which those calling for high rates continue to be disappointed). Net inflows into equities are positive, which hasn’t happened since 2017, but inflows into bond funds are soaring and poised to surpass records established in 2019 and 2020. Witness this week’s extremely strong auction of 10-year Treasuries yielding just above a paltry 1.30%. Bank of America’s proprietary gauge of bulls and bears betrays no fear in bonds or stocks. Therefore, Fundstrat says, consensus is “everything rallies” into year-end. The drivers: the delta variant peaks soon and there’s no fall wave; economic momentum strengthens as “delta panic” fades; a bottoming 10-year slowly trends up; the bipartisan infrastructure bill passes; the Fed doesn’t surprise; and favorable seasonality arrives with fall. Fingers crossed—cyclical Value stocks, tech stocks and bonds all rally. Decent odds!

There are reasons to think Value, which after nine months of leadership has lagged tech by 22% over the last two months, still has some gas. Many Value stocks remain cheap and neglected (Yardeni notes P/Es for oil & gas exploration and production, telecommunication services, household appliances, steel, insurance and chemicals are all in the single digits). And yet Jefferies finds the cyclical Value cohort has had the best positive earnings revisions by far relative to bond proxies (staples, utilities, etc.) and Growth (mainly tech, which nonetheless has been a strong defensive play throughout the Covid crisis). The risk is macro. Restaurant bookings declined notably last week in states susceptible to delta infections (those with low vaccination rates). But the impacts barely show up in the national data. JP Morgan thinks the S&P 500 Value Index is poised to break out as bond yields look set to cheapen. Indeed, more than 60% of Financials traded to a 20-day high this week. An expanding new high list often signals the resumption of an uptrend.

What catalysts might give us that elusive correction? Perhaps delta breakthrough cases prove to be a bigger problem than thought. The Kaiser Family Foundation reported less than 1% of vaccinated people have gotten breakthrough infections, but the CDC only counts hospitalized patients, due to its own lack of staffing. Companies have recently delayed reopening plans and schools are fighting about masks and vaccinations. As Covid stimulus fades, expectations that spending from the $1.2 trillion bipartisan infrastructure bill may pick up some slack seem overly optimistic—its multiplier effect is calculated in years, not months (more below). Dems are pushing ahead with their $3.5 trillion reconciliation bill that would increase the deficit $1.75 trillion over the next decade. All this new spending would begin to hit just as the Fed starts to taper, taking away a critical relief valve for the market. Since March 2020, the central bank’s QE purchases have matched unexpected deficits related to Covid-19 stimulus almost to the dollar. Wolfe Research thinks this will put valuations under significant pressure. We’ll see. First up may be the looming debt ceiling fight. Prospects for a stalemate appear as high as they were in 2011, when a bitter standoff led to a downgrade of U.S. federal debt, a 20% correction and a rally in bonds. Republicans have made clear they have no interest in raising the ceiling. Should be an interesting autumn.

Positives

  • Plenty of jobs New claims met strong expectations and continuing claims beat (about three-quarters of the reduction the past two months has come from the states that ended the $300 extra weekly benefit), dropping the implied unemployment rate to a new recovery low. Job openings topped 10 million, a new record, as businesses worked overtime to try and fill positions.
  • Taper yellow light July CPI came in just below Street forecasts as clothing, used-car prices and airfares sharply moderated. However, owner’s equivalent rent, which has an outsized influence, rose and could be set to break out. Shelter prices could determine the inflation narrative in coming months.
  • Peak variant? After many days of test-positivity ratios rising in all 50 states, suddenly they are falling in five of them. As we've experienced all the various coronavirus waves, there always has been an early hint that new cases are about to start falling.

Negatives

  • Variant worries start to bite Michigan consumer sentiment plunged in early August to near a 10-year low on worsening attitudes about all aspects of the economy, from personal finances to prospects for inflation and unemployment. And the NFIB’s optimism gauge in July slipped off June’s 8-month high as sales expectations, earnings trends and the outlook for business conditions deteriorated.
  • Taper green light The tight labor market is pushing up wages—restaurant prices rose at an abnormally strong pace for the third straight month in July, following 5-6 months of substantial wage increases for food service workers. Average hourly earnings in July jumped at a 4% annual rate.
  • Taper green light July headline PPI rose much more than expected, putting the y/y gain at 7.8%. The core rate also spiked, pushing the y/y rate to an above-consensus 6.2%. Various PPI sub-indexes, ISM prices paid and imported inflation continue to trend higher, indicating a broad firming in prices could continue as more demand comes back online.

What else

Gold not so golden Gold is often thought to be a hedge against runaway inflation, but in reviewing the relationship between gold and inflation over several decades, Strategas Research found mixed results. On an inflation-adjusted basis, gold remains below the all-time high reached in the late 1970s and early 1980s. 

The payoff is going to take a while History suggests the output multiplier from infrastructure investment is large; between 0.5-1.2, which means for every $100 spent on infrastructure, GDP will be boosted by $50-120 in the medium term (excluding pay-fors). But infrastructure is not shovel ready and Evercore ISI thinks it won’t help until 2024, so midterm-worried Dems really need a large reconciliation spend, much of which would be expected to hit in 2022.

We’re thinking about Big Tech all wrong Contrary to conventional wisdom that tech replaces/hurts labor, tech creates jobs on net and accelerates income growth. When productivity goes up, as it did in the 1990s, real median family income goes up. Ditto the last expansion, when poverty collapsed to a record low. Indeed, directly and indirectly, innovation boosts income. Consider: tech now accounts for 32% of capital expenditures and 4% of total payrolls.

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Tags Equity . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Growth stocks are typically more volatile than value stocks.

Price-earnings multiples (P/E) reflect the ratio of stock prices to per-share common earnings. The lower the number, the lower the price of stocks relative to earnings.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

S&P 500/Citigroup Value Index: A market capitalization-weighted index of the stocks in the Standard & Poor's 500 Index having the lowest price to book ratios. The index consists of approximately half of the S&P 500 on a market capitalization basis. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

The Institute of Supply Management (ISM) nonmanufacturing index is a composite, forward-looking index derived from a monthly survey of U.S. businesses.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

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