Unprecedented unprecedented Unprecedented unprecedented http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\island-small.jpg July 16 2021 July 16 2021

Unprecedented unprecedented

It's easy money all over despite rising inflation.

Published July 16 2021
My Content

The more the merrier. The ECB is now expanding its balance sheet at a $1.1 trillion annual rate, in line with Fed QE. Indeed, central banks are maintaining dovish stances all around the world. And now China has joined the party, lowering its policy rate this week. On Capitol Hill, Chair Powell acknowledged “surprise” at inflation’s run-up but no change in policy, while Dems struck a compromise on a $3.5 trillion human infrastructure bill. Added to the bipartisan infrastructure deal, the two packages if passed would add an unprecedented $4.1 trillion in net new spending, just what Biden wanted. That’s on top of the unprecedented $1.9 trillion American Rescue Plan (ARP) passed in March through budget reconciliation, i.e., simple majority vote, which was on top of last year’s unprecedented $3 trillion in Covid-related fiscal stimulus. This week, new monthly checks up to $300 and covering 90% of all children in America began hitting mailboxes and inboxes (more below). With the Dems holding the slimmest of majorities and midterms around the corner, everybody’s trying to keep his job next year—including Powell, who’s up for reappointment. Cowen thinks the bipartisan plan has a decent chance at passage because it’s “infrastructure” as both sides see it (roads, bridges, broadband, the grid.) The far bigger reconciliation compromise faces a more difficult path. Two numbers that matter: how much will be deficit financed, and how much will be offset. As Republicans did with Trump’s tax cuts, Dems could use “dynamic scoring’’ that says the bill will lift growth and thus partly pay for itself. Sen. Manchin, a level head (?), is key. He’s said, “We’ve put enough free money out.” Then again, he drew a similar red line before voting for ARP in March. “Voodoo economics” vintage the Reagan years is alive and well.

The oddities of the Covid pandemic have made it exceptionally difficult to understand where things stand. A surging Delta variant, strong inflation data (more below), peak growth, a slowing China (more below) and a Fed that’s sending hawkish notes even if Powell isn’t keep adding to the Wall of Worry. But Empirical Research is skeptical of the assumption that if the Fed sneezes, the economy will quickly develop pneumonia. The housing market, the most rate-sensitive part of the economy, is roaring. Job growth is getting stronger (more below). Manufacturing and services are humming near record highs. Lumber prices have plunged and prices-paid measures appear to be topping out, possibly a sign supply chain imbalances are working out. Then again, Strategas Research shares that eight of 15 major commodities it tracks are just 10% off recent highs, and Evercore ISI says 98% of companies it surveys report ongoing supply constraints. A majority of Fed Beige Book respondents don’t think inflation is “transitory,’’ a word Powell interestingly avoided using in his written testimony before Congress. (I’ll have more on inflation in a special in two weeks.) Low bond yields usually occur near the end of a cycle, and were far from that, with forecasts calling for the fastest growth in GDP this year in four decades. The problem with trying to read signals from this bond market is it isn’t exactly a free market. It’s been rigged since March 23, 2020, Yardeni says, by the Fed’s QE-forever.

With August recess and a debt ceiling looming, government headline risks are on the rise. Growth stocks—and we’re really talking Big Tech—acted defensively during last year’s uncertainties and again appear to be a refuge. After a tough winter-early spring, growth names have been rising, partly because growth was oversold, partly because “peak growth’’ talk dampened the cyclical trade where value stocks largely reside and possibly because investors are shifting money from Chinese tech (no friend in President Xi Jinping) to U.S. tech. Even as various indexes keep flirting with new highs, there’s a lot of churn underneath, with significantly more decliners relative to advancers. The mega-caps are what’s pulling the market higher. As we approach the historically weak July-August months, Wall Street strategists are increasingly suggesting a growth-value balance. But our equity CEO still favors the cyclical tilt as we think economic growth—and earnings—will surprise to the upside over the next 1.5 years. And yet our year-end 4,500 S&P target leaves just 3% upside from this point, suggesting post-July 4 summertime fireworks still ahead. Biden and Powell are trying to balance wildly opposing forces (progressives vs. moderates for the former, inflation hawks vs. employment doves for the latter)—things could get choppy. You know, in the last 15 months, the number of times I’ve said unprecedented is, well, unprecedented.

Positives

  • Back-to-school sales should be spectacular June retail sales unexpectedly rose at the headline level and jumped 1.3% ex-autos. Clothing and restaurants (we’re eating out again, with restaurants reporting no impact from the Delta variant) posted solid gains. The massive new child tax credits (about half the size of the entire jobless benefit program) that arrived this week are almost certain to juice spending among lower-to-middle income cohorts.
  • If it weren’t for cars Ex-autos, manufacturing output rose in June to its highest level since January 2020. A shortage of computer chips caused auto production to contract at a 25% annual rate in the first half, despite sales that are running at a 17 million pace. With chip makers closing the gap, production is expected to accelerate sharply the rest of the year.
  • A back-half rocket booster? The NFIB Small Business Optimism Index surprised in June, rising to its highest level since October. Notably, a record number said they plan to create new jobs and, with inventories at a record low, the percentage planning to add to stock grew to an 8-month high.

Negatives

  • Even Powell is surprised June’s consumer and producer price gauges came in well above forecasts. The 5.4% year-over-year (y/y) jump in CPI was the biggest increase since August 2008, and the 4.5% y/y increase in the core rate was a 30-year high. The NFIB survey found 47% of business owners raising average selling prices, a 40-year high and potentially a positive sign for corporate top lines.
  • Consumers starting to worry, too The University of Michigan’s sentiment gauge for July dropped to a 5-month low amid growing concerns about inflationary pressure, with complaints about rising prices on homes, vehicles and household durables hitting record highs.
  • China is the second-largest economy in the world The decision to lower policy rates by the People’s Bank of China’s came as a crackdown on credit there is starting to bite its economy. China reported Q2 GDP expanded 7.9% versus a year ago, short of estimates and significantly below Q1's 18.3% y/y increase.

What else

Here come the jobs? With GDP recovering sharply in the year’s first half, Applied Global Macro Research thinks the typical lagged response in employment is set to follow and will push nonfarm payroll growth to nearly 1 million a month over summer and into fall.

Unintended consequences Thanks to hand washing, masks and stay-home edicts, the flu vanished in the Covid pandemic year. But the isolation came at a cost—drug overdoses soared 30% in 2020.

Companies may beat again Following the biggest beat in history in Q1, consensus estimates for Q2 earnings-per-share have risen 7% the past three months, the biggest upward revision since the SEC put public disclosure requirements in place in 2000.

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Tags Equity . Inflation . Monetary Policy . Fiscal Policy . 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.

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.

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.

Stocks are subject to risks and fluctuate in value.

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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