In this week’s Monday Market Insights, we discuss our view on monetary policy, China, and the health of the U.S. stock market. In the chart of the week, we highlight the current state of the labor market, and finally, we discuss current investor positioning and how that might affect market leadership going forward.
Top Weekly Themes
- Patience is a Virtue. We have been consistent in our view that the Federal Reserve will begin a gradual reduction in monthly asset purchases later this year or early in 2022. Minutes from the July Fed meeting do not meaningfully change this calculation. Even if an announcement of “tapering” plans were to come next week in Jackson Hole, the Fed’s commitment to providing the market with “ample notice” would mean the earliest possible start date for tapering would be November. The labor market has improved by all measurable standards but likely falls short of the Fed’s gauge of “substantial further progress.” In addition, the Delta variant remains a wild card, with weaker economic data prints indicating at least some impact on the economy. For that reason, we continue to believe that the Fed will be patient with any withdrawal of monetary support. What appears clear to us is that the Fed would like to complete tapering before initiating any rate hikes. With an 8-12 month tapering timeline, that put rates hikes closer to very late 2022 or early 2023.
- Bear in a China Shop. The Chinese Communist Party is now clearly stepping away from the free market leaning policies of previous regimes. China entered the World Trade Organization in 2001, ushering in a period of rapid growth and economic reforms within the region. Of late, Beijing has unleashed a regulation tidal wave that we believe changes how investors should think about investing in China. China’s 5-year regulation plan will explicitly target large companies with significant market share, useful data, or political influence. Tech companies were first, but we doubt they will be the only target. In our view, more regulation equals less innovation, less capital investment, and slower growth. Our exposure to China is not insignificant within our emerging markets allocations, and we are thinking about what, if any, adjustments need to be made.
- Under the Surface. To better understand the true position of the stock market, we believe it is important to look beyond the headline level of market-cap-weighted indexes like the S&P 500. Although only just off record highs, we continue to see some deterioration under the surface. Although not yet alarming, the percentage of S&P 500 stocks trading above their 200-day moving price average has fallen from over 95% to 79%. This indicates that fewer stocks have been participating in the markets recent advance, leaving the index more vulnerable to a pullback. With an understanding that more volatility is possible, if not probable, we would stop short of recommending a defensive posture in portfolios. We continue to believe that although economic growth is slowing from peak levels, the expansion is far from over.
|Russell 1000 Value||(0.6)||18.8||35.6||10.83||11.72||1.87|
|Russell 1000 Growth||(0.8)||20.4||34.1||24.38||24.36||0.66|
|MSCI EM (Emerging Markets)||(1.8)||1.6||18.5||10.65||10.56||2.07*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||0.4||(0.4)||0.0||5.72||3.29||1.42|
|Bloomberg Barclays US High Yield – Corporate||0.3||5.0||10.9||7.17||6.86||3.75|
|Bloomberg Barclays Municipal Bond||0.1||1.6||3.4||5.26||3.45||0.96|
|Bloomberg Barclays Global Aggregate x US (Country)||0.4||(3.1)||1.0||4.10||2.10||0.85|
|Crude Oil WTI (NYM $/bbl) Continuous||4.8||49.6||89.7||1.7||10.6||72.6|
|Natural Gas (NYM $/mmbtu) Continuous||11.1||116.2||131.2||25.4||13.3||5.5|
|Gold NYMEX Near Term ($/ozt)||0.1||(5.3)||(8.4)||14.5||6.4||1,792.4|
|Copper Cash Official LME ($/mt)||2.5||22.6||39.3||16.9||15.0||9,488.5|
|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||1.19||1.17||1.12||1.18|
|Japanese Yen per U.S. Dollar||110.34||103.25||105.48||112.10||102.40||109.30|
|U.S. Dollar per British Pounds||1.37||1.37||1.29||1.31||1.32||1.38|
Chart of the Week
The Labor Market – Plenty of Healing Left
- Adjusted for the drop in labor force participation after the onset of the pandemic (left side), the unemployment rate still sits at an estimated 8.5% (right side).
- Labor force participation has remained stubbornly low since the pandemic, and we will need to see meaningful improvement there for the employment situation in the U.S. to fully recover.
- With additional unemployment benefits set to expire and plentiful job openings across many industries, the next few months will be very important to the evolution of this story.
- Although inflation has been the headline concern, we believe the labor market will play a key role as the Fed considers the removal of accommodative monetary policy.
Commentary – From one Extreme to the Other
Reversion to the mean may be the closest thing to a physical law that we can observe in financial markets. Extremes tend not to last very long, even though investors are prone to creating them. Eventually, asset prices find a proper balance which is a better reflection of prevailing fundamentals.
This year, we’ve seen several different price extremes. One example would be asset flows into sectors that would benefit from an economic “re-opening”. Traditionally cyclical sectors like Financials, Energy, Materials, and Industrials were the darlings of early 2021. As seen in the chart below, investors piled into these stocks, hoping to take advantage of a renewed economic expansion. By the end of the first quarter, rolling 3-month flows into these sectors reached $18 billion, well into the 99th percentile of history and statically extreme. This usually serves as a good contra indicator for future performance. True to form, these sectors subsequently lagged the broad market.
As economic growth rates began to peak and the Delta variant caused concerns about another round of lockdowns, these flows reversed as investors abandoned stocks associated with the recovery. Although the economy may slow, recent investment flows may be reflective of an overly pessimistic outlook, again providing a contra indicator for future stock market leadership.
Recent outflows from cyclical sectors are likely to reverse in the coming months