Markets seem unfazed by hotter inflation  

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen's 2021 Q2 Outlook
  • U.S. economy: A strong economic backdrop bodes well for U.S. economic growth.
  • Global economy: Should also surge as large developed countries sprint into the post-pandemic world.
  • Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
  • Fixed income: Take more risk in credit-sensitive parts of the market.
  • Equities: Bullish on cyclicals but looking for opportunities again in growth.
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

“The world will little note, nor long remember what we say here, but it can never forget what they did here. It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. — Abraham Lincoln

How might markets move as Europe becomes the “peak growth” leader?

May’s preliminary composite Purchasing Managers’ Indexes (PMIs) for major economies confirm that the timing and pace of improved economic activity are broadly determined by each country’s respective policy response to the pandemic. (Composite PMIs measure both manufacturing and service-sector activity.) The varying degrees of progress reinforce our outlook that the global recovery will be sequential rather than synchronous.
The U.S., for example, is off to the fastest and strongest recovery thanks to a high rate of vaccinations, massive monetary and fiscal stimulus, and consumers’ readiness to shop, travel and dine out. Closely behind in rebounding from the virus are the U.K. and eurozone, so their growth rates are likely to peak within the next few months. Not surprisingly, all three economies reported booming — and in some instances record-setting — PMIs last month.5
In contrast, Japan has barely begun to vaccinate its population, leading to a fresh outbreak and another round of business lockdowns. Despite this setback, we believe developed Asia and the broad emerging markets will reap the benefits of mass vaccinations via a return to economic normalcy.
How this sequential global recovery might inform investors’ portfolio construction is a trickier consideration. Despite posting multiple record highs this year on the back of forecast-busting earnings growth, the S&P 500 Index (11.9% YTD) lags Europe’s STOXX 600 Index (12.5% in local terms).6 The S&P 500’s underperformance is mainly due to its less cyclical composition, with a higher weighting in technology companies. After outpacing the other 10 S&P 500 sectors by a wide margin in 2020 with an 43.9% total return, interest-rate-sensitive tech stocks have fared relatively poorly (+5.9% for the year to date) amid rising rates.7 
In fixed-income markets, the stellar economic and first-quarter earnings results that have fueled European stocks have taken a toll on holders of international (ex-U.S.) developed-market bonds, which trail many segments of the U.S. debt market thus far in the second quarter.8 Interest rates in Europe have been grinding higher as countries move toward achieving herd immunity and ending COVID-19 mitigation efforts.9 (Bond yields move in the opposite direction of their prices and tend to rise as economies strengthen.) 
Against that mixed backdrop, we think that industries worldwide that are emerging from lockdowns, in addition to economically sensitive sectors like banks and industrial companies, should do well. In our view, broader global exposure to these areas may be a more effective strategy than trying to “hopscotch” from country to country, chasing the latest regional outperformer. The sequential nature of the global recovery should provide more stable growth and calmer markets overall as periods of decelerating growth in one country are offset by accelerating activity in others.
Also on our radar: the direction of the U.S. dollar. The greenback has resumed its weakening trend in the second quarter after strengthening markedly in the first amid extra stimulus, early vaccinations and the accompanying rise in interest rates.10 Now, with the yield gap closing between U.S. and European sovereign debt, overseas demand for Treasuries and other U.S. government bonds has waned, and with it, demand for dollars needed to purchase those securities.
The dollar’s near-term path is especially challenging to forecast given a variety of crosscurrents. With the U.S. economy accelerating in the current quarter but likely to cool off in the second half of 2021, yields should still rise over the course of the year, even if only modestly. While rising rates could push the dollar higher, the transfer of growth leadership from the U.S. to other countries might provide a counterweight, keeping it rangebound.

U.S. personal income’s down, while spending, savings and inflation are up

The last day prior to the Memorial Day weekend provided key snapshots into the financial health of U.S. households for April and the extent to which people have been opening their wallets.
  • U.S. personal income fell by 13.1% in April, a smaller drop than expected, but a substantial one nonetheless. A sharp decline from March’s 21% increase was inevitable, as that month’s gain was fueled by the $1,400 per person stimulus checks issued under the American Rescue Plan Act (ARPA).11
  • With incomes falling, how did personal spending hold up? Pretty well, actually, rising 0.5% in April after an upwardly revised 4.7% in March. And we’ve detected a pattern: fiscal stimulus creates a burst of spending, but only for a month or so. To illustrate, the government’s late-December $600 stimulus checks drove a 3.4% jump in personal spending in January, which was followed by a 1% drop in February. And March’s strong rebound, fueled by much larger ($1,400) federal assistance courtesy of the ARPA, preceded April’s far more modest increase.12
  • Households saved 14.9% of their incomes in April, down about half from the prior month but otherwise consistent with their behavior in non-stimulus months since the pandemic began.13 Instead of looking at month-to-month comparisons, though, we should consider the average household’s accumulated savings over the past year. In short, we simply have never (until now) experienced a recession in which private-sector balance sheets improved so immensely and so quickly.
  • Inflation has been dominating the headlines over the past month, and the Fed’s preferred inflation barometer — the core Personal Consumption Expenditures (PCE) index — came in a little hotter than expected in April (as did the Consumer Price Index a few weeks back). Core PCE inflation, which excludes food and energy costs, has risen at a 4.9% annualized rate over the past three months. Prices of durable goods (+1.4%) and the costs associated with reopening a handful of service sectors drove the PCE number higher in April, whereas rising energy costs had been the primary driver in prior months.14
One last item: the second estimate of first-quarter GDP growth, released last Thursday, was unchanged from the preliminary estimate at 6.4% — a robust rate of expansion. This reinforced the most important narrative of the first quarter: people (and businesses) bought more “stuff” than the economy could produce, causing imports to surge and inventories to plummet. Based on the second-quarter data we’ve received thus far, the economic backdrop hasn’t changed much. If anything, we expect to see even stronger demand growth in the April-June period, meaning inventory restocking will have to wait until the second half of the year.
  1. Marketwatch, FactSet
  2. Russell
  3. Russell
  4. Treasury.gov
  5. IHS Markit
  6. Bloomberg
  7. FactSet, Bloomberg
  8. Bloomberg
  9. Marketwatch
  10. Marketwatch
  11. BEA via Haver
  12. BEA via Haver
  13. BEA via Haver
  14. Bloomberg
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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