The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
- U.S. economy: The growth rate has peaked but will remain high throughout 2021.
- Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
- Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
- Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
- Equities: The best opportunities may now lie outside the U.S.
- Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.
Quote of the week:
“Morning found us calmly unaware/Noon burn gold into our hair/At night, we swim the laughin' sea/When summer's gone/Where will we be?” – “Summer’s Almost Gone” (The Doors)
Taking a minute to analyze last week’s bumpy ride for markets
After last Monday’s modest gain, the S&P 500 Index fell 0.7% on Tuesday, largely due to worse-than-expected retail sales data, followed by Wednesday’s 1.07% decline — the S&P 500’s biggest one-day drop in a month.3 The culprit for the mid-week equity “meltdown”? Investors’ interpretation – correct or not – of minutes from the Federal Reserve’s July meeting, released on August 18. The minutes indicated that the majority of voting members would like to taper the Fed’s monthly $120 billion quantitative easing (QE) bond-buying program by the end of this year. These purchases have supported financial markets by providing liquidity and “insurance” against unexpected deteriorations in economic activity.
The equity market’s negative reaction to potential Fed tightening bore some similarities to 2013’s taper tantrum, albeit on a far smaller scale. (Stocks sold off for about a month after then-Fed Chair Ben Bernanke merely indicated that the Fed would begin reducing its QE purchases at some future date.)
But one key difference between this “mini tantrum” and 2013’s meltdown is the behavior of Treasury markets. Yields spiked from May through December 2013, with that of the bellwether 10-year note nearly doubling.4 Last Wednesday, the 10-year yield merely edged up a few basis points to around 1.30% in the immediate wake of the minutes’ release before settling at 1.27% for the day and 1.26% on Friday.5 Bond investors are not yet seeing a connection between the end of QE and a durable rise in long-term interest rates. Even if the Fed makes a formal announcement in the coming months, we don’t anticipate a Treasury market reaction close to 2013’s.
So how much stock do we put into the minutes? Not much, especially considering they’re already stale due to (1) the rapid spread of the Delta variant over the past month, which may be weighing on consumer spending, (2) the decline in market-based measure of inflation expectations and (3) general weakness in U.S. economic data releases relative to expectations since July’s meeting.
As for the taper, the range of outcomes for the timing of both the announcement and the taper itself has narrowed. Whether the taper starts in November, December or January, markets won’t be caught by surprise. We continue to believe that the Fed’s doves will gain the upper hand, meaning the Fed will wait until the fourth quarter to communicate the beginning of the end of QE before actually trimming in January.
In our view, these officials can now make a better case for being patient in tapering (compared to July) than their hawkish counterparts due to the Delta variant and its ability to slow the economy, falling inflation expectations and weaker consumer spending. And by delaying the announcement, they’ll be able to examine the health of the labor market via jobs reports that will be released after the expiration of enhanced unemployment aid.
We remain bullish on stocks in the near-to-medium term
Before volatility arrived in the middle of last week, the S&P 500 Index hit a benchmark of note. While last Monday’s 0.3% gain garnered little attention in and of itself, it marked yet another record high for the index and a 100% advance since stocks bottomed on March 23, 2020, when much of the country was in or about to enter lockdown mode.6 Of course, the index didn’t hold those gains for long, as the growth concerns we covered in the previous section crept in starting on Tuesday.
However, the S&P 500 managed to end the week on a positive note even if it was unable to recover losses from earlier in the week. U.S. equities have shown considerable resilience this summer in the face of multiple risks, which include:
- COVID-19 cases are rising across much of the world, due mostly to the Delta variant. This threatens the global economic recovery at a time when some of the largest developed economies — including the U.S. and U.K. — have likely reached their peak, post-pandemic growth rates.
- The variant may put the brakes on reopening economies in the emerging markets (EM) and those EM countries trying to maintain momentum, like China, where factory output and retail sales slowed sharply in July.
- U.S. fiscal stimulus, particularly unemployment insurance, is about to end in September.
- The Fed is leaning toward tightening monetary policy this year by tapering its $120 billion/month quantitative easing bond purchases.
That’s a lot for markets to digest, but equity investors have mostly shrugged their shoulders. Why have they looked past these hurdles?
- Effective vaccinations have given consumers added confidence to shop, travel, dine out and attend outdoor activities such as sporting events and concerts. This has made investors more confident about future corporate earnings.
- Household balance sheets remain strong, aided by a pickup in employee wage growth.
- Hiring has accelerated, as witnessed by U.S. job creation of 900,000+ in June and July.7
- Threats posed by geopolitical events risks seemingly have abated. Since the 2007-08 global financial crisis, flare-ups such as those emanating from North Korea, the Middle East, China and most recently, Afghanistan, have fueled short-term equity market volatility without leaving lasting damage to stock prices.
- Stocks still look relatively attractive compared to many safe-haven assets that are already richly priced, including U.S. Treasuries and the U.S. dollar. Meanwhile, gold prices are near a multi-year high.8
And in our view, the S&P 500 has room to grind even higher over the next 6-18 months despite its robust 18% year-to-date advance.9 Not only have stellar corporate earnings pushed down valuations since the start of the year, but the pace of positive earnings revisions continues apace. Moreover, the Fed has no plans to raise interest rates for at least another year and probably longer.
Non-U.S. markets may rally as well. Central bank policy worldwide remains accommodative and, in terms of economic activity, the best may be yet to come assuming the Delta variant is kept at bay. In July, the eurozone enjoyed its best month of manufacturing and service sector growth in more than 15 years.10 Additionally, most economies in Asia (including Japan) and South America appear poised to break out once vaccination rates rise to levels that allow for the lifting of restrictions.