S&P 500 surges to another all-time high despite Friday fade

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 Nuveens 2021 Fourth-Quarter Outlook:
  • U.S. economy: Stimulus wearing off but growth remains solid. More workers needed.
  • Global economy: Slowing from its fastest pace in decades even as parts of Asia and the emerging markets are set to reopen.
  • Policy watch: Policy is shifting from “extremely accommodative” to merely “quite accommodative.”
  • Fixed income: Income generation remains a challenge as rates rise gently from very low levels.
  • Equities: Valuations have come down but remain high relative to history; earnings growth will be key to returns.
  • Asset allocation: Balance the risk of hotter inflation with that of slower growth.

Quote of the week:

“I meant what I said and I said what I meant. An elephant's faithful one-hundred percent!” – Dr. Seuss

Watch what consumers do, not what they say

Over the past two weeks, two conflicting data points about U.S. consumers have emerged:
  • The first, November’s University of Michigan Index of Consumer Sentiment (released November 12) showed confidence among respondents plunging to its lowest level in exactly 10 years.4 Much of that decline seems to have been driven by political party affiliation. To illustrate, self-identified Republicans rated the economy as worse now than in April 2020, when the country was largely shut down in the early days of the pandemic, or even in March 2009, when the survey generated its lowest readings during the global financial crisis.5

    Political affiliations have often skewed the outcome of this survey, making it less useful as a barometer for gauging consumer optimism (or pessimism). Another weakness of the survey is the rarely accurate poll of inflation expectations that it includes. Consumers’ best estimate of inflation tends to be the latest impression they formed after making a high-frequency purchase like gasoline or groceries. This view is entirely backward-looking, because (not surprisingly) few people have their own inflation forecasting models.

    While the U.S. economy today is significantly stronger — by just about every measure — than it was in March 2009 or April 2020, we’re concerned that a significant portion of consumers seem to believe that’s not the case. The risk is that depressed sentiment could significantly dent consumer spending. Fortunately, that hasn’t happened, at least not yet.

  • The other data point, released last week, that bears watching as a barometer of the consumer mindset: retail sales for October, which showed a 16.3% surge over the past year (and a healthy 1.7% increase in October alone), far outpacing the 6.2% year-over-year jump in inflation as measured by the Consumer Price Index.6 This indicates that people haven’t just been spending more money due to rising costs, they’ve also been buying more stuff.
Although October’s headline retail sales were solid, some of the underlying details do warrant caution. For example, spending in restaurants — which is included in the retail sales calculation — was flat in October, meaning folks actually ate out less as menu prices rose. If that trend were to continue, it certainly wouldn’t bolster overall retails sales growth or help steer the U.S. economy on its road back to normal.
What would be of the greatest assistance? Having households spend down their considerable excess savings amassed during the pandemic, with (we hope) a continued beneficial shift in spending away from expensive goods and toward cheaper services. Otherwise, beleaguered supply chains might never get a chance to breathe and catch up to demand, and transitory inflation, as the Federal Reserve has defined it, will stretch out longer than it already has.

Hedging inflation risks has gotten more expensive

Anyone who bought Treasury Inflation-Protected Securities (TIPS) back in January to hedge against higher inflation is probably happy they did so. The asset class is beating all other major fixed income categories for the year to date, even edging out high yield and leveraged loans despite their higher correlations to U.S. equities, which have rallied hard in 2021.7
TIPS have maintained their strong performance thus far in the fourth quarter even though month-over-month inflation as measured by the Consumer Price Index (CPI) peaked back in the second quarter. The good times for TIPS keep on rolling because inflation expectations have continued to rise.
In effect, investors are being asked to accept lower returns in exchange for inflation insurance. TIPS yields have plummeted to all-time lows, pushing their prices to all-time highs.8 (As with all bonds, yields and prices on TIPS move in opposite directions.) Investors in developed markets outside the U.S. are also paying steep premiums on bonds linked to inflation, including those issued by the U.K. and Germany, where inflation has surged to multi-year peaks.9
Then there’s gold, another investment long considered an inflation fighter that behaves like TIPS in most environments — but which hasn’t reached record-high prices due in large part to its nosedive as the panic of 2020 subsided. (Gold, viewed as a safe haven during times of uncertainty, often suffers when sentiment strengthens.) Still, gold has been rallying alongside TIPS this month, perhaps as a response to the higher-than-expected October U.S. CPI data.10
But investors in these asset classes may be disappointed if real (i.e., after inflation) interest rates rise next year. Higher real rates make gold less attractive, since it pays neither dividends nor interest. Meanwhile, TIPS — which tend to perform well when interest rates are rising due to higher inflation — may be a less compelling investment if real rates are on the upswing.
  1. Bloomberg, S&P 500 Index via Haver
  2. Bloomberg
  3. Bureau of Economic Analysis via Haver
  4. University of Michigan, Federal Reserve Bank of St. Louis
  5. Bloomberg
  6. Bureau of Labor Statistics, Census Bureau
  7. Bloomberg
  8. Bloomberg
  9. Office for National Statistics via Haver, Federal Statistical Office via Haver
  10. Marketwatch
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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