In this week’s Monday Market Insights, we provide an overview of earnings announcements for the second quarter of 2021, the recent outperformance of “higher quality” stocks, and some takeaways from the PMI data recently released by the Institute of Supply Management. In our Chart of the Week, we highlight the recent struggles of equity markets in China. Finally, in the Commentary section, we assess whether the COVID-19 Delta Variant poses a significant risk to the economy during the second half of this year.
Top Weekly Themes
- Stocks Continue to Deliver on the Earnings Front – With equity valuations above historical averages across several different metrics (P/E, P/B, P/S, etc.), we figured that corporations would need to deliver solid second quarter earnings growth for the market to keep marching higher. Fortunately for equity investors, there was an abundance of positive second-quarter earnings announcements. Based on data compiled by FactSet Research Systems, Inc. (“FactSet”), approximately 60% of stocks that comprise the S&P 500 Index have reported Q2 2021 earnings as of July 30. Out of this sample, roughly 89% of companies have reported earnings-per-share (“EPS”) that exceeded consensus estimates. “Earnings surprise,” a metric that encapsulates the percentage difference between actual earnings and sell-side analyst forecasts, was nearly 17% for this sample of stocks. Revenue growth (roughly 23% for the 2Q 2021), not cost-cutting, was the catalyst that drove earnings growth. While concerns about inflation and supply chain disruptions were cited by certain companies that announced earnings, thus far we have not seen an impact on profit margins, which are well above historical averages. Year-over-year comparisons will get more difficult over the back half of 2021. However, the results of this earnings season have not resulted in any adjustments to our equity market forecasts from earlier in the year.
- Quality is Outperforming More Speculative Beta – Since the beginning of the third quarter, we started to see a clear trend emerge within various domestic equity investment styles (growth, value, small-cap, etc.). Over the back half of 2020, high beta stocks, many of which had minuscule or negative earnings, materially outperformed. More recently, higher-quality stocks, or those with higher ROEs (Return on Equity), positive earnings momentum, and solid free cash flow yields, have fared more favorably. The decline in interest rates and concerns over the new COVID-19 Delta variant seem to have caused more cyclical segments (value, small-cap), which typically have greater exposure to low quality stocks, to underperform. We think it is likely that rates will move higher and cyclical stocks will begin to outperform as anxiety over the latest COVID-19 news begins to dissipate. That said, we think it makes sense to emphasize higher-quality cyclicals and not the most speculative stocks that led the market as the reopening trade first gained traction several months ago.
- PMIs Showing No Signs of Economic Weakness – Both Services and Manufacturing PMI data released by the Institute of Supply Management last week signify solid economic activity. On the manufacturing side, readings were moderately lower than the prior month but were not indicative of lackluster growth. One takeaway is that survey responses signified strong demand, but also supply chain disruptions and labor shortages. The magnitude of pent-up demand was captured by the latest PMI Services reading, which reached an all-time high for the second time in the last three months. Elevated PMIs, which are leading economic indicators, have historically led to positive earnings revisions for stocks. We think it’s probable that earnings will continue to surprise to the upside as elevated PMI readings will likely persist over the back half of 2021.
Returns Table
| Equities | Week(%) | YTD(%) | 1-Year(%) | 3-Year(%) | 5-Year(%) | Div Yield |
|---|---|---|---|---|---|---|
| S&P 500 | 0.6 | (0.8) | 26.1 | 24.25 | 17.94 | 1.22 |
| Russell 1000 Value | 1.2 | 1.5 | 22.7 | 16.79 | 11.35 | 1.77 |
| Russell 1000 Growth | 0.0 | (3.5) | 23.4 | 30.79 | 23.83 | 0.64 |
| Russell 2000 | (0.8) | (3.1) | 3.3 | 16.00 | 11.25 | 0.94 |
| MSCI EAFE | (0.5) | 0.7 | 10.3 | 12.91 | 9.74 | 2.51* |
| MSCI EM (Emerging Markets) | 3.7 | 2.9 | (4.0) | 11.03 | 10.03 | 2.38* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Div Yield |
| Bloomberg Barclays US Aggregate | (0.3) | (1.5) | (1.9) | 4.21 | 3.16 | 1.98 |
| Bloomberg Barclays US High Yield – Corporate | (0.2) | (0.6) | 4.6 | 7.50 | 5.93 | 4.45 |
| Bloomberg Barclays Municipal Bond | (0.7) | (0.9) | 0.7 | 4.30 | 3.74 | 1.31 |
| Bloomberg Barclays Global Aggregate x US (Country) | 0.3 | (0.3) | (5.8) | 2.44 | 2.94 | 1.15 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | 6.2 | 9.9 | 55.3 | 17.0 | 9.3 | 82.6 |
| Natural Gas (NYM $/mmbtu) Continuous | 16.6 | 21.6 | 59.8 | 13.7 | 5.1 | 4.3 |
| Gold NYMEX Near Term ($/ozt) | 0.1 | (0.0) | (0.9) | 12.4 | 8.8 | 1,827.2 |
| Copper Cash Official LME ($/mt) | (1.2) | (0.2) | 21.1 | 17.7 | 10.9 | 9,665.0 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.13 | 1.24 | 1.22 | 1.15 | 1.07 | 1.14 |
| Japanese Yen per U.S. Dollar | 115.79 | 115.16 | 104.20 | 108.41 | 114.03 | 114.85 |
| U.S. Dollar per British Pounds | 1.36 | 1.35 | 1.36 | 1.28 | 1.22 | 1.37 |
Chart of the Week
Recent Equity Market Weakness in China
Equity Market Returns Denoted by ETFs (6/30/2021– 8/6/2021)
* SOURCE: MSCI INC. (SEE COPYRIGHT DECLARATION).
** BCA CALCULATION.
Source: BCA Research
Takeaways
- The first chart illustrates the recent weakness in Chinese stocks. Given that China constitutes roughly 40% of the MSCI EM Index, the impact on relative performance compared to the US equity market, as measured by the S&P 500 Index, has been profound. The second chart just highlights the magnitude of the decline from peak levels of certain China equity market indices and a select group of stocks domiciled in the country.
- So, what caused the recent market malaise that impacted the world’s second-largest economy? In late July, regulators in China imposed a series of regulations and increased surveillance on several different economic sectors, that include, but are not limited to technology, education, food delivery, and real estate. While questions remain regarding the timing of increased scrutiny on specific segments of the economy, it seems quite plausible that the Chinese Communist Party (CCP) is concerned about the level of power, influence, and profitability wielded by some of the country’s “new economy” stocks. This news was not welcomed by investors as many are reassessing the risks of deploying capital to corporations that can have their entire business model upended by abrupt changes in government policy.
- It’s possible that investors have overreacted to this news and Chinese stocks could experience a short-term bounce. There is also an abundance of rapidly expanding new economy stocks in China that can be appealing to investors looking for long-term growth. However, increased regulation will likely cause downward pressure on equity market multiples to compensate for the greater degree of uncertainty. We have a neutral weight to emerging markets and think it’s imprudent to increase exposure unless we gain greater comfort regarding the regulatory environment going forward.
Commentary: Will the COVID-19 Delta Variant Stifle the US Economic Recovery?
Many investors seem worried that the COVID-19 Delta Variant could pose major challenges to the economy and financial markets over the next several months. In our opinion, the news surrounding COVID-19 is highly politicized. As investors, we try to gather data and analyze the information without any regard to preconceived political notions. We acknowledge that there are risks, especially as the data pertaining to the virus shifts over time. Despite the uncertainty, our base case scenario is that widespread restrictions will be avoided, thus not leading to significant economic weakness.
We think it’s helpful to evaluate daily cases within countries that previously reported a significant increase in Delta Variant infections. In the UK and India, COVID-19 cases rapidly accelerated, then peaked, and subsequently started to precipitously fall – all within a two-month span.
In addition, the vaccine rollout in the UK dramatically reduced deaths. There are no guarantees, but we think it’s likely we will see a similar pattern in the U.S. A sizable portion of the U.S. population has been vaccinated, which would make mandatory lockdowns hard to politically justify.
Although the Delta Variant has recently surfaced in the U.S., as of now there is no evidence that its existence has deterred individuals from spending time outside of their homes.
