Monday, August 2, 2021
U.S. and international equities
In July, the U.S. major market indexes finished higher while international equities, as represented by the developed international markets (MSCI EAFE), and the emerging markets (MSCI EM), finished the month in opposite directions.
Lower interest rates aid growth, rate-sensitive sectors
In the midst of an economic recovery, last month growth equities, as denoted by the Russell 1000 Growth Index, outperformed value (Russell 1000 Value) by over 2 percentage points. The information technology and communication services sectors performed well given the belief that even in the midst of an economic recovery these stocks can continue to post solid results in comparison with the economically-sensitive value stocks. The drop in the 10-year US Treasury yield below 1.3% helped growth stocks advance, while also sparking a rally in the interest rate sensitive real estate and utilities sectors, which all outperformed the broad market in July.
Stalled small caps
The Russell 2000 has gained more than 100% since bottoming during late March 2000 on the back of a new economic expansion. July represented one of the larger pullbacks in small caps since March 2000, potentially attributable to relatively high valuations as well as concerns over the direction of the economic recovery as COVID-19 Delta variant cases rise worldwide.
Tumultuous month for emerging markets
In addition to small caps, emerging market equities had a quite tumultuous July and at one point in July were in the red for 2021. The emergence of increased Delta variant COVID-19 cases played a role in July’s results, along with Chinese regulations placed on U.S.-listed Chinese stocks and ongoing and multi-faceted U.S.-China tensions. Going forward, emerging market stock performance could be quite challenged if these headwinds strengthen.
This month has been quite volatile for the energy sector as well as its commodity counterparts. Energy stocks have had a tremendous run since last fall. During June, the sector was up almost 47% for the year, nearly double the next best performing S&P 500 sector. In July, the sector managed to lose over 8% as the S&P 500 rose. These stocks appear to be pricing in a ceiling for West Texas Intermediate (WTI) crude, potentially on concerns about increasing supplies globally. These concerns could also be reflected in the fact that oil finished lower in July.
Natural gas had an excellent July, gaining over 7%. Spot prices reflect an increase in natural gas demand due to warmer than normal weather across the country. However, prices in the natural gas futures markets are signaling falling prices next year, possibly contributing to lower equity prices for oil and gas production companies.
July’s fixed income results
The benchmark Bloomberg Barclays U.S. Aggregate Index finished the month higher, as fixed income investors continue to take solace in the Fed’s policy stance concerning inflation and several technical factors put downward pressure on interest rates. Municipals (Bloomberg Barclays Municipal index) and its high yield counterparts (Bloomberg Barclays High Yield Municipal Index) have performed well for four straight months. These bonds have been aided by municipal support in a number of fiscal stimulus packages along with the discussion of higher taxes. The Bloomberg Barclay High Yield Municipal Index has gained over 7% this year, making it the top performing fixed income sector year-to-date.
Both International bonds (FTSE World Government Bond Index) and emerging markets debt (JP Morgan Emerging Markets Bond Index (EMBI)), ended the month higher, while their respective yields declined.
U.S. economic data recap
Inflation: Consumer prices increased for the fourth straight month in June. The headline Consumer Price Index (CPI) annual rise was the largest increase in 13 years. Prices for used vehicles, hotels, and restaurant meals were the largest drivers in June. Moreover, one major reason for the increase was the continued base-effects due to the depressed economic conditions last year from COVID-19. Removing volatile food and energy prices, the June Core Consumer Price Index increased 4.5% from June 2020, the largest increase since September 1991.
Producer prices in June increased at the fastest rate in more than 10 years. Year-over-year, the June PPI increased over 7%, while its month-over-month increase was 1.0%. June’s inflation showed to be quite substantial, however, we believe any inflationary pressure will mostly prove transitory.
U.S. consumer: The Conference Board’s Consumer Confidence Index increased in July to its highest reading in 17 months, but is still just off pre-pandemic highs. The increase in the Present Situations Index drove the increase in July, while the expectations component remained flat. The University of Michigan consumer sentiment survey declined to a five-month low in July. The rising prices of durable goods led to a sharp decline in these purchases. Moreover, the reading missed economists’ expectations.
Retail sales: Retail sales increased in June ahead of the Bloomberg consensus forecast and rose almost 20% vs. June 2020. These increases were broad based in 9 out of 13 categories. Sales growth was strong in department stores, clothing, and restaurants, consistent with the reopening, while electronics sales rebounded solidly after May weakness.
U.S. home sales: Home sales in the U.S. reached a fourteen month low in June. Rising home prices and low inventory are driving potential buyers out of the market. In addition, builders have been constrained given higher lumber prices along with building material and labor shortages. Over 350,000 new homes were on the market in June, which was an increase of almost 20,000 more than in May.
Small business sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index increased to an eight-month high in June. Moreover, seven out of ten areas of the index increased. Over the past couple of months, the NFIB report has expressed concern about a tightening job market. This trend continued in June with 46% of business owners reported unfillable job openings. Moreover, 26% of businesses are also planning to boost compensation in the next three months. Fifty percent of business owners reported higher average selling prices, the largest share in over 40 years.
Federal Reserve (Fed) news: The Federal Reserve (Fed), after its July Federal Open Market Committee (FOMC) meeting, made no changes to current monetary policy, as most market participants expected. However, the Fed hinted that the economic recovery is progressing to a point where less monetary support will be needed.
U.S. employment: The U.S. unemployment rate has declined substantially from last year’s peak but at 5.8%, it is still well off full employment levels. Even as we successfully handle the COVID-19 mitigation efforts and reopen the economy, labor market slack needs to improve in order for the economy to reach full-employment.
As we continue to battle COVID-19 along with the variants, the “transitory” effects of inflation and the Fed’s perception of this could play a role in this year’s market results. Strong earnings have been an important driver of this year’s strong stock market performance and second quarter earnings season has been for the most part very encouraging. The ability for companies to successfully absorb higher input costs and pass them onto their consumers will play an important role in future earnings results.
We believe that inflation is mostly transitory and will stabilize once the economy completes its reopening, supply chains are fully operational, and labor shortages ease. To conclude, the major questions that market participants want answered are how long the “transitory” period will last and what impact that may have on Fed policy, interest rates, economic growth, and corporate profits.
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