September 6, 2021
In what may be considered “Delta Dawn”, the current variation of Covid is beginning to show up in the economic data. Friday’s huge miss on employment (250k vs est of 750k) caused barely a ripple in the financial markets. After much head scratching, investor’s figured that the Fed would continue to keep rates lower for longer as well as postponing their tapering of bond buying. Bad news is good news when it comes to the financial markets today. The surprises continue to occur on the downside, from employment to the various assessments of economic activity. Employment in the “customer facing” portions of the economy were essentially flat from the prior month. Manufacturing added jobs and the employment rate fell again, getting close to 5%, as the total workforce is contracting with more retiring all together. This week will be light on economic data, save for the produce price report on Friday. The next focus for the markets is inflation, as worries are beginning to surface that growth is slowing with inflation not being as transitory as the Fed expects.
The markets continue to grind higher, making 50+ new all-time highs this year and pushing the valuation levels of the market to all-time highs as well. Why? Investors are back to the belief that there is no alternative to stocks. Bond yields are very low, money market rates are essentially zero and the Fed continues to support “risk taking” by keeping rates low. How long can it last? Longer than many currently believe. Yes, a correction of 3-5% is long overdue, however a larger decline is not yet on the horizon. At some point the markets will have enough of the debt creation and decline, but so far, the signs of a larger decline are not evident. The market internals remain less than stellar, with stocks making new all-time highs still lower than their peak in June. The number of stocks above their long-term average price has been falling since March, another indication that investors are focused on the largest of the large US stocks. The markets have shifted back toward growth and away from the “re opening” trades, fearing that Covid will continue to make any economic recovery very uneven. If inflationary pressures continue to build and economic activity slows further, investors may indeed decide that the Fed will have no alternative but to raise rates. That could drop the curtain on the advance, but that may be months away.
The bond market has reversed course a bit over the last few weeks as the difference between short and intermediate term treasuries is getting larger. The difference between high yield and treasuries is also contracting. Both conditions have been supportive of risk taking in the markets and has led to the recent rally in stocks. Until the markets believe that the Fed will be raising rates to combat inflation, the interest rate environment should support stocks. Worries about a larger decline in stocks are usually preceded by a flatter Treasury curve and widening spread between high yield and Treasuries, which is not the case today. The tipping point will likely occur when investors begin to worry more about the likelihood that inflation is not transitory. The Fed’s favorite indicators of inflation are all well above their 2% target and rising. So far, the markets are buying the transitory label on inflation.
The song remains the same in the equity markets, the largest US stocks are doing well, while the rest of the markets suffer. International stocks gained some traction with the decline in the US dollar. The dollar has been relatively strong as the US economy has performed better than many of their international competitors. Looking over the longer term, the dollar has been bouncing within a range since last July. A break lower could indicate better strength internationally, higher would mean a stronger US relative to others. A declining dollar would also mean that international holdings would fare well as those gains buy more of an ever-cheaper dollar. The international markets, especially emerging markets, are among the best long-term estimated returns. However, that is predicated upon a more normal functioning global economy.
The long-term key to the markets may lie in strength of inflation and investor’s fears that it is more than transitory. That is not likely to show up in the next inflation report or two, but persistence into yearend may concern investors.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.