What have you done for me lately?
Perhaps a market hung up on stimulus should appreciate what it has.
Seems as if we’re at peak growth. Some data, most notably on housing, has disappointed (more below). From $3 gas to record high home prices to soaring used-car prices to supply chain bottlenecks, inflation looks to keep climbing. Year-over-year (y/y) CPI already is running a full percentage point above its 5-year average. Every time that’s happened since its March 1980 peak, the S&P 500 has fallen at a 3% annual rate (although in each case, inflation ultimately proved transitory). One Wall Street source is even worried about stagflation (!), believing the Fed is behind the eight ball as it appears to be putting income inequality/housing equity on equal par with its longtime dual mandate of maximum employment and price stability. Uncertainty over what the Fed will do wasn’t helped by the April meeting minutes, which ran counter to Powell’s past assurances (let’s just call this a white lie)—and the consensus view—that taper is far away. Some think a taper surprise could send the 10-year to 3%, a level last seen in November 2018. The confusion is weighing on the equity market, sending the put-call ratio to a 7-month high this week. With the bias on yields higher and the correlation between the S&P and 10-year Treasury yield at multiyear lows, bonds aren’t much of a refuge.
On the other hand, price measures less distorted by the pandemic, such as the Labor Department’s Employment Cost Index, show compensation growth hasn’t moved much. Rising productivity—up 4.1% y/y in Q1, the most in 11 years—is helping offset cost pressures. S&P forward revenues per share and profit margins rose to 12% and 13% y/y through early May, respectively, despite higher material and other input prices. Supply chain issues appear to be working themselves out, too, as companies restore depleted inventories and consumers shift spending from goods to services as the reopening broadens. Lumber prices, for example, have plunged 27%. Corn has tumbled 12%, as have memory chips, belying the widespread semiconductor shortage thesis. It will take time for supply adjustments to play out, making for likely continued near-term market choppiness. Labor shortages represent one of the biggest hurdles. But as more states eliminate expanded jobless benefits (20 and counting) and more schools fully reopen, that should take care of itself. Moreover, monetary and fiscal policies look to remain highly supportive, even if taper comes early and the Biden administration struggles to pass more stimulus. After an 11% move in just a few months, market re-pricing is understandable, given a much wider distribution of economic and policy outcomes than was the case a few months ago. But the fundamentals remain bullish, as any slowing is coming off an exceptionally strong pace. A slower V makes for a longer one, too.
CEO confidence is soaring (more below), a positive sign for earnings and capital expenditures. Q2 earnings are expected to be just as strong as Q1’s blowout, with Industrials, Consumer Discretionary and Energy stocks getting the biggest boost. Empirical Research has long thought 2021 estimates were too low, in part because the current generation of analysts never experienced a true economic boom. Their early expectations for $175 per share have risen to $196, but Empirical expects they will top $200, probably by a significant margin. (Now, these are the people I want to hang with.) The global profit backdrop is extremely positive, too. Both the consensus global (+33.6%) and European (+36.3%) 1-month net earnings-per-share revisions reached an all-time high at the end of April, with sales, earnings and dividend expectations closer to their historical peaks than troughs. JP Morgan doubts this pace can continue in the year’s back half, but cheap stocks are still cheap, with a lot of life left in Value and beaten-down momentum stocks. Institutions are bracing for a summer correction—active manager equity exposure is at a 13-month low and institutional cash is near last May’s record peak (makes it dangerous to be a bear)—which argues it will be milder than feared if it comes. It all may come down to the Fed—its models suggest it will take 2.5 to 3.5 years for unemployment to fall enough to justify moving off zero—and whether investors take the central bank at its word. Right now, they aren’t. Futures markets are pricing in the first hike a year from now. That means tapering would come sooner, perhaps as early as this summer, with the rhetoric on any change proving critical to the equity market. So, maybe the V slows. That’s a good thing.
- Bullish bosses Conference Board CEO confidence jumped in the second quarter to its highest level in the survey’s 45 years. “The challenge no longer is staying afloat, but keeping pace—in particular, with a likely resurgence of labor shortages experienced before the pandemic,’’ said Roger Ferguson Jr., a Conference Board trustee and former Fed vice chair.
- Bullish indicators April Conference Board leading indicators jumped 1.6% and 17% y/y, the most since last July’s post-lockdown surge. On a smoothed y/y basis, which dampens the base effect, the composite reading of the index and its coincident and lagging components rose at their fastest pace since December 1983. Fundstrat says the strong showing implies an S&P reading above 4,480 by November.
- More bullish indicators Markit’s early take on May services and manufacturing activity in the U.S. surprised, with both jumping to record highs. Overseas surveys also were strong, with the eurozone composite at a 39-month high and the U.K. composite its highest since 1988. Also, the AIA Architectural Billings Index hit a 14-year high in April, with new project inquiries and design contracts setting records.
- This should give us pause Existing home sales fell a third straight month in April, as available supply held at record lows and prices rose to record highs. Single-family starts and permits also slipped, although homebuilder confidence remained elevated. The scale of the rise in home prices during this boom is nearly the same as it was in the lead up to the housing bust that precipitated the global financial crisis.
- Inflation watch Strategas Research’s proprietary surveys of industries found slower supplier deliveries pushing an indicator of future price increases to a record high. The prices paid component of the Philly Fed’s manufacturing PMI rose to its highest level since 1980, while the New York Fed’s companion Empire survey said prices received set a new high.
- Watch the dollar! After a 3-month rally on global growth differentials and relative interest rates favorable to the U.S., relative rates have reversed, causing the dollar to lose ground since March. Going forward, America’s more generous fiscal stimulus measures potentially make the U.S. more vulnerable to an inflationary overshoot—a negative for both real rates and the greenback, especially with global growth rotating from the U.S. to other developed markets.
Getting closer to normal Trend Macro estimates U.S. adult herd immunity has surpassed 75%, and Covid cases in India are rolling over hard—33% off their highs. To woo the vaccine wary, West Virginia is giving a $100 bond to 16- to 35-year-olds who get a shot, Ohio is giving a lottery ticket for the chance to win $1 million in each of five weekly drawings and Detroit is giving $50 to every recipient.
You might as well be open! Covid continues to defy categorization and understanding. Of the top five of the 49 states in 2-week declining trajectories for new cases, three are locked-down blue states (New York, Pennsylvania and Michigan) and two are wide-open red states (Florida and Texas).
Can we count on the consumer? Wolfe Research doubts the anticipated post-pandemic spending splurge will come to pass. It notes the bulk of the estimated $2 trillion in excess savings Americans have built up thanks to unprecedented stimulus is held by higher-income households, where the propensity to consume more isn’t great.