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 Q2 2021 Outlook:
- U.S. economy: Poised for its best year of GDP growth in decades.
- 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:
“Time spent among trees is never time wasted.” – Anonymous
Higher inflation is here … temporarily
U.S. inflation readings have begun to move higher, as we expected they would. Base effects are appearing in the year-over-year data, as last March’s weak inflation results rolled out of the 12-month calculation. Due in part to that numerical quirk, the Consumer Price Index (CPI) hit a 2½-year peak of 2.6% for the 12 months ending in March.7 And in March alone, CPI jumped 0.6%, its largest one-month climb since August 2012.8 The primary culprit for last month’s move? Higher energy costs, for gasoline in particular. Prices at the pump surged 9.1%, accounting for nearly half of March’s total CPI increase.9 Costs associated with service industries made up much of the other half, as demand for airline tickets, hotels and dining began to pick up.
Meanwhile, core CPI, which strips away volatile food and energy prices, was up 0.3% in March and 1.6% over the past year — in both cases, far below the headline print.10 If base effects were prevalent in March, they’re likely to be even more powerful when April 2021 year-over-year CPI is released. Prices slumped badly last April, especially for energy. And when that decline is reflected in the 12-month calculation, headline and core inflation will almost certainly top 3% and 2%, respectively, in our view. But those anticipated spikes needn’t be a source of undue concern, as we doubt they’ll presage an inflationary spiral.
That said, monthly inflation data could remain elevated for the next few months. Why?
- Surveys of both large and small businesses indicate that owners are expecting to raise prices. According to March’s NFIB Small Business Optimism Index, for example, 34% of survey respondents plan price hikes, the highest percentage in over a decade.11
- Hotel stays cost 4.4% more in March than they did in February, on average.12
- The cost of admission to sporting events rose 2.6% last month.12
- Car insurance (+3.3%) and public transportation (+0.7%) were two other categories that saw above-average price increases in March.12
In all of these cases, however, prices are still below their pre-pandemic peaks, meaning runaway inflation hasn’t kicked in. But reflation has, amid demand that’s slowly returning to normal. Of course, in some categories prices may eventually rise well past prior peaks this summer, as a rapidly growing number of people reengage with industries that had been hard by COVID-19. More folks will be traveling and enjoying their favorite pastimes once again, and the businesses they patronize may need to scramble to restock and hire. Building up staff could be problematic, though: the NFIB survey also revealed that employers are struggling to find qualified applicants for open positions.
So as last year’s base effects wear off and the positive demand shock from the post-pandemic reopening fades, inflation (and the market’s current preoccupation with it) should begin to recede. That could occur by the start of the fourth quarter, if not a bit sooner. In the meantime, expect more attention on the American Rescue Plan Act’s boost in unemployment insurance payments as more businesses try to hire. For the roughly 16.5 million individuals currently collecting some form of jobless benefits, advance notice that the more generous provisions will expire in September as scheduled could provide strong motivation for job hunters to accelerate their searches — potentially resulting in a helpful influx of labor supply this summer.13
First-quarter earnings season should raise the ceiling a bit more for equity markets
Corporate earnings season has begun and promises to be a mixture of unusual and great.
Well, the usual pattern is for analysts to lower their earnings expectations during the quarter, only to see their revised projections far exceeded when actual earnings are reported. But that doesn’t apply here. Revisions for the first quarter and 2021 as a whole have been quite positive over the past three months, with analysts unable to ignore (1) the sharp drop in COVID-19 cases and (2) the passage of close to $3 trillion in fiscal stimulus since December. Both of these favorable developments, reflected in a wide range of recent, better-than-forecast economic data, are proving more powerful than the Street’s penchant for pessimism. The latest example of ongoing upbeat numbers, released last week: March’s 9.8% surge in retail sales.14
And why “great”?
Even after these recent upward revisions, we still believe — as we did at the start of the year — that S&P 500 Index earnings will comfortably exceed expectations. Backing up our call have been stellar readings from coincident indicators like the ISM Manufacturing Purchasing Managers’ Index (PMI), which are highly correlated to a very high percentage of positive “beats.”15 (These indicators show the current state of economic activity within a particular area or sector.) Indeed, as economists have been scrambling — unsuccessfully, so far — to keep up with positive economic surprises, analysts may be wearing their erasers to the nub as they move their earnings forecasts higher.
For the full year, consensus estimates have risen from less than 20% to over 25% since January.16 But we expect them to eventually top 30%. Based on the price-to-earnings (P/E) ratio, robust earnings growth — and positive momentum in earnings revisions — effectively move the ceiling higher for stock prices, allowing indexes such as the S&P 500 to continue hitting new all-time highs without necessarily making the market prohibitively expensive.
We also believe defensive stocks (in sectors like utilities and consumer staples) will significantly lag cyclical (economically sensitive) areas of the market, such as consumer discretionary and energy, for the remainder of 2021. Many cyclical companies suffered over the past 13+ months due to economic lockdowns across most of the country, and they are poised for a rebound.
Financials, another cyclical sector and one of the first to report financial results each quarter, have gotten off to an excellent start this earnings season, thanks in large part to the cumulative increase in interest rates since March 2020. Banks, a substantial component of the financials sector, benefit from the wider spread between short-term rates (which determine the interest they pay on deposits) and long-term rates (on which they base how much interest to charge on loans).