This week’s Monday Market Insights reviews the recent stock market rally, examines the topic of “market leadership,” and provides a more in-depth analysis of the latest labor market report. In our Chart of the Week, we highlight the recent flattening of the yield curve. In the Commentary section, we illustrate the ample supply of liquid assets within the financial system.
- Equity Markets Rally – A combination of fears over Omicron (a new COVID-19 variant), concerns over inflation, more hawkish rhetoric from the Federal Reserve (“Fed”), and elevated tax-loss harvesting all seem like plausible reasons for the decline in equity prices the last few days of November. Since bottoming on December 1, the S&P 500 Index has risen over 4% (thru 12/8/21), while small-cap equities, as measured by the Russell 2000 Index, have advanced approximately 6%. Positive news on the COVID-19 front in recent days seems to have quelled fears about lockdowns and restrictions that could halt growth. While equity volatility has risen, the stock market has held key technical support levels, and credit spreads have not widened to the extent that would lead us to believe that a more sizable drawdown is imminent. Thus, we don’t believe that recent equity market fluctuations justify material shifts from an asset allocation standpoint.
- Mixed Messages on the Market Leadership Front – The markets are at an interesting crossroad in our opinion. On a year-to-date (YTD) basis, the Russell 2000 Value Index, a proxy for cyclical stocks, has performed in line with the Russell 1000 Growth Index, which has held up better in down markets during the post-COVID-19 environment. Both indices are up over 26% thus far in 2021. In addition, both the Energy and Information Technology sectors, which have exhibited low correlation in recent years, have both significantly outperformed the broad market. Furthermore, sectors with the largest percentage of stocks reaching 3-month relative highs and lows are both defensive and cyclical in nature. For example, a larger percentage of REITs, Consumer Staples, and Energy stocks have experienced positive price momentum, while Health Care, Financials, and Information Technology equities have not fared as well from a market leadership standpoint. As the cycle progresses and earnings growth starts to decelerate, we think it makes sense to focus our attention on stocks with strong profitability metrics and reasonable debt levels across various investment styles (growth/value) and market cap segments (large, mid, small).
- Job Growth Continues – According to the Bureau of Labor Statistics (“BLS”), nonfarm payroll employment rose by 210,000 in November, a figure that fell well short of the 550,000-consensus estimate. On the surface, the employment report was disappointing. However, there were some positive takeaways after digging a little deeper into the data. First, job gains from the previous two months were revised upwards by 82,000, and the labor force participation rate continued to climb higher. In addition, the unemployment rate declined to 4.2%, which is calculated using BLS household survey data – a broader measure of the U.S. workforce (includes self-employed, agricultural workers) compared to the BLS payroll survey output used to compile the headline nonfarm payroll figure. According to the BLS household survey, the number of unemployed individuals fell by 542,000 last month. The payroll and household survey results can diverge, but November’s spread was relatively large compared to historical levels. Overall, we don’t think the November jobs report signifies a weakening economy, nor does it justify a material shift in Fed monetary policy.
|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|
|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|
|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: The Yield Curve Has Been Flattening
- The first chart shows the spread (interest rate differential) between 10-Year and 2-Year Treasuries going back to 1980. Over the past couple of months, the yield curve has been flattening as long-term rates have been falling. Recent comments from Fed officials about potentially accelerating the pace of QE tapering have caused the yield curve to flatten in an atypical fashion outside of recessions or periods of material market stress. The bond market has been signaling that the Fed may tighten monetary policy too aggressively in response to transitory inflationary pressures. Assuming the market’s expectations are correct, such a policy mistake could curb economic growth and keep a lid on long-term rates. We think a reasonable question is: Has the Fed missed its chance to remove accommodative monetary policy? In our opinion, the Fed will likely proceed with caution, and we don’t see any reason to change our current fixed income exposure.
- The second chart shows S&P 500 Index returns both preceding and following the first interest rate hike by the Fed over different business cycles. The sample size is relatively small and may not be indicative of future events. However, the market returns highlighted above indicate that, in previous cycles, the first increase in short-term rates (federal funds) did not have a negative impact on equity markets over most periods. Keep in mind that the Fed has just started QE tapering. It is highly unlikely that Fed would even consider the possibility of raising rates until monthly bond purchase activity ceased altogether.
Commentary: Ample Liquidity in the Financial System
The first chart listed below shows the amount of deposits held within the U.S. Commercial banks. Deposits are at record levels and have risen considerably (roughly $4 trillion) since before the pandemic surfaced in early 2020. While lending has not kept pace with deposit growth, banks are well-capitalized, and there is more than sufficient liquidity to support both consumer and business spending. While there are plenty of catalysts that could eventually lead to an economic slowdown, we don’t think a liquidity crisis (i.e., 2008/2009) would be the likely culprit.
Cash, as a percentage of total assets on corporate balance sheets, remains well above historical averages, as illustrated by the chart above. Corporations have adequate funds for capital expenditures, dividend payments, or stock buybacks. While elevated cash levels do not make companies impervious to market downturns, it can help them to sustain operations during more challenging environments.