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BMT Monday Market Insights – November 8, 2021

In this week’s Monday Market Insights, we discuss the Federal Reserve’s plan to withdraw pandemic-related stimulus, the most recent iteration of the spending bill in Washington, and what we believe the stock market is telling us about economic growth.  In the chart of the week, we highlight an opportunity in small-cap stocks and discuss how investors should be positioning portfolios in 2022.

Top Weekly Themes

Federal Reserve Stays the Course.  This month, the Fed began tapering its $120 billion monthly bond purchases (“quantitative easing”) by $15 billion each month.  With purchases expected to be completely phased out by June 2022, the Fed will be in a better position to assess its interest rate policy based on the evolution of inflation and the economy.  We continue to believe the Fed will be patient before committing to a rate hike.  In our view, there are compelling reasons to think pandemic-induced inflation will ease next year, providing ample cover for the Fed to keep rates lower than the bond market is currently reflecting. 

What’s In?  What’s Out?  As Democrats continue to negotiate over President Biden’s Build Back Better agenda, some significant compromises have been made.  Policymakers are getting close to having a tax plan that finances the spending without raising the individual, capital gains, dividend, estate, and corporate tax rates directly.  Although changes are still being made, the basic framework for a deal is becoming clearer.  We are likely weeks away from passage through both the House and Senate, but the impact on financial markets, and corporate earnings, will be much smaller than initially anticipated.

Wisdom of Crowds.  The stock market is often an excellent leading economic indicator.  There is wisdom in stock prices, and the leadership profile of the market is often telling.  Although we believe economic growth will slow later in 2022 (more on that below), for now, the market is anticipating an economic growth reacceleration.  We see strength across areas like autos, transports, financials, and semiconductors.  This type of leadership suggests confidence in near-term economic growth and at least some improvement in global supply chain disruptions.

Returns Table

EquitiesWeek(%)YTD(%)1-Year(%)3-Year(%)5-Year(%)Div Yield(%)
S&P 500(4.0)21.725.019.9117.701.26
Russell 1000 Value(5.1)16.619.911.1010.111.90
Russell 1000 Growth(3.7)22.727.028.4524.890.64
Russell 2000(7.9)9.718.113.3311.760.93
MSCI EAFE(1.3)8.312.211.0310.102.48*
MSCI EM (Emerging Markets)(2.1)(2.9)2.610.0910.282.24*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate1.0(1.2)(0.7)5.553.751.68
Bloomberg Barclays US High Yield – Corporate(0.1)3.55.37.456.334.74
Bloomberg Barclays Municipal Bond0.31.42.05.104.471.11
Bloomberg Barclays Global Aggregate x US (Country)1.6(5.9)(4.1)3.733.201.01
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous(16.4)35.147.28.85.165.6
Natural Gas (NYM $/mmbtu) Continuous(16.7)68.647.8(2.6)4.04.3
Gold NYMEX Near Term ($/ozt)(0.1)(5.9)(1.8)13.48.81,781.6
Copper Cash Official LME ($/mt)(2.9)23.625.215.310.69,571.0
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro1.121.221.201.131.061.13
Japanese Yen per U.S. Dollar115.45103.25104.49113.55114.41112.97
U.S. Dollar per British Pounds1.331.371.341.281.261.33
As of 12/1/21 (close). Three-year and 5-year returns are annualized. *Dividend Yield For MSCI EAFE and MSCI EM are from 10/29/2021.

Chart of the Week: ‘Tis the Season for Small Caps

Source: Strategas Research Partners

Takeaways

  • The market has entered a seasonal period in which small-cap stocks often outperform large-cap.
  • After eight months of sideways trading for small-caps, this historical pattern appears to be repeating, with small-cap stock indexes starting to break out to new highs.
  • As discussed in previous pieces, BMT remains overweight small-cap stocks within our recommended asset allocations.

Commentary

For all of 2021, BMT has maintained a preference for more cyclically oriented exposure as the global economy emerges from the depth of the pandemic.  We continue to believe these exposures will serve us well as the calendar turns.  The economic growth scare of the summer is behind us, and the Delta variant has largely run its course.  Investors have again started to leave the safety of large-cap growth stocks, with better relative performance emerging in areas like small-cap.

However, we believe there is a shot clock on cyclical market leadership.  As we move into the second half of 2022, we think investors will be well served to reduce cyclical exposure as economic growth downshifts.  We are not predicting a recession – far from it.  However, a rate of economic growth will have equity market implications.

Source: Cornerstone Macro Research

Various data series we track point to a slowdown in the economy in the second half of 2022.  As leading economic indicators like the Purchasing Managers’ Manufacturing Index start to contract, equity market leadership is likely to shift.  As seen in the chart above, as higher prices and higher interest rates work their way through the economy, growth is almost always impacted.

Source: Cornerstone Macro Research

Regardless of the direction of interest rates, Growth often outperforms Value when economic growth slows.  As growth becomes harder to find, investors pay a premium for companies who are still able to demonstrate positive earnings momentum.

As a result, we will likely begin to increase our exposure to large-cap and growth stocks in anticipation of this macroeconomic shift.

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