Top Weekly Themes
- A Broad Market is a Strong Market. Although at times it might not feel like it, with small-cap and technology stocks well off their highs, this is a very broad market advance. Unlike 2020, where a very narrow corner of the market drove stock indexes higher, today we see the opposite condition. 94% of stocks in the S&P 500 are above their 200-day moving price averages versus just 55% in the fourth quarter of 2020. We have not seen a market with this many stocks participating in the advance since 2013. Even with technology stocks correcting, 90% of the sector remains in an uptrend. We may see a consolidation or correction, but a significant market top would be exceedingly unusual under these conditions.
- “Earning” Your Returns. Last week the Institute for Supply Management’s March manufacturing reading (ISM PMI) reached 64.7. This is the highest reading since 1983. Strong ISM manufacturing readings are highly correlated to above-average positive earnings revisions. We anticipate persistently elevated PMI readings, and therefore a consistent progression of upwardly revised earnings forecasts. Cyclically-oriented sectors like materials, industrials, and financials have most to gain from increased earnings expectations. For context, a reading of 60 in the new orders component of the ISM Manufacturing Index would forecast a 20% gain in forward earnings expectations throughout 2021. If the S&P 500 maintains its current price-to-earnings ratio, that would suggest a level of about 4,400 by year-end.
- Spend More, Tax More. Last week the Biden administration rolled out their plans for an additional $2 trillion of spending focused on transport infrastructure, manufacturing, R&D, housing, and elderly care. Without getting into the details, a key takeaway is that the spending is proposed to take place over eight years, and paid for over 15 years with higher taxes – most notably an increase in the corporate tax rate from 21% to 28%. Based on current estimates, this would reduce 2022 S&P 500 earnings by $11.82, taking forecasts from $202 to $190. Said another way, it would reduce the forecasted growth rate to 8% from 15%. Interestingly, looking back to 2017, analysts did not begin to reflect the Tax Cuts and Jobs Act’s benefits in their 2018 EPS estimates until after the bill was signed. Therefore, although investors will need to consider the impact of higher taxes on corporate earnings and valuations, we likely have some time before this reality begins to impact asset prices.
Returns Table
| Equities | Week (%) | YTD (%) | 1-Year (%) | 3-Year (%) | 5-Year (%) | Div Yield (%) |
|---|---|---|---|---|---|---|
| S&P 500 | 2.8 | 7.4 | 65.5 | 17.24 | 16.42 | 1.41 |
| Russell 1000 Value | 1.9 | 12.3 | 65.3 | 11.31 | 11.86 | 1.97 |
| Russell 1000 Growth | 4.0 | 2.5 | 72.8 | 23.44 | 21.24 | 0.73 |
| Russell 2000 | 3.3 | 14.4 | 112.7 | 15.33 | 16.63 | 0.95 |
| MSCI EAFE | 1.4 | 4.1 | 49.9 | 6.78 | 9.96 | 2.31* |
| MSCI EM (Emerging Markets) | 3.7 | 3.8 | 65.3 | 7.43 | 13.09 | 1.82* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Div Yield |
| Bloomberg Barclays US Aggregate | 0.1 | (3.1) | 0.9 | 4.77 | 3.18 | 1.59 |
| Bloomberg Barclays US High Yield – Corporate | 0.5 | 1.0 | 25.3 | 6.91 | 8.10 | 4.16 |
| Bloomberg Barclays Municipal Bond | 0.1 | (0.3) | 7.6 | 4.94 | 3.49 | 1.17 |
| Bloomberg Barclays Global Aggregate x US (Country) | (0.6) | (4.9) | 7.0 | 1.67 | 2.43 | 0.91 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | 4.9 | 26.6 | 202.6 | (1.8) | 10.8 | 61.5 |
| Natural Gas (NYM $/mmbtu) Continuous | 0.9 | 4.5 | 66.3 | (1.2) | 6.2 | 2.6 |
| Gold NYMEX Near Term ($/ozt) | 0.1 | (8.8) | 9.4 | 9.3 | 7.2 | 1,726.5 |
| Copper Cash Official LME ($/mt) | (0.1) | 13.3 | 83.7 | 9.5 | 12.4 | 8,768.0 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.18 | 1.22 | 1.09 | 1.23 | 1.13 | 1.18 |
| Japanese Yen per U.S. Dollar | 109.14 | 103.25 | 107.12 | 106.35 | 112.39 | 110.60 |
| U.S. Dollar per British Pounds | 1.37 | 1.37 | 1.24 | 1.40 | 1.42 | 1.38 |
Chart of the Week: Not Your Grandfather’s “Momentum”
Takeaways
- In recent years, technology stocks have been synonymous with momentum. Today, tech accounts for nearly 35% of the widely tracked iShares Momentum ETF (MTUM).
- This is about to change. MTUM will rebalance during the last week of May, and the weighting to technology will likely be cut in half. Estimates forecast that Financials, Consumer Discretionary, and Industrials will carry the largest weights, and with that, additional flows will likely be attracted to those sectors.
- This simple reconstitution is yet another catalyst for further underperformance from technology. Those that want exposure to momentum, whether through a passive ETF or an actively managed strategy, will by rule be owning less tech and more value.
Commentary – Growth Still Significantly More Expensive Than Value
Although growth stock underperformance in 2021 has been noteworthy (trailing value by about 8%), it hasn’t made a dent in the historically wide valuation difference between the two styles. Let’s not forget that over the past ten years, growth outperformed value by an average of 7% per year. We think many investors still haven’t come to terms with the idea that value can outperform for an extended period. As we wrote in an earlier piece, “The problem is that current prices [for growth stocks] necessitate a level of future growth that will be very difficult to realize.” We still believe this to be the case. For example, Zoom is down 43% from its all-time high, but the stock still trades at 84x next year’s earnings. Tesla is similar, down 23% from its high, but still trades at 145x forward earnings.
Value’s outperformance this year has only driven the price-to-earnings premium in the tech-heavy growth index back to two standard deviations above normal. We have a long way to go before the valuation gap normalizes.
