This week’s Monday Market Insights addresses the topic of “stagflation” promulgated by news outlets, provides an earnings update for a sample of multinational financial services companies, and points out how the recent rise in interest rates is not strictly a U.S. phenomenon. In our Chart of the Week, we mention the recent decline in COVID-19 cases. In the Commentary section, we examine the recent rise in energy prices and potential ramifications for consumers.
- Is Stagflation a Real Threat? – Given a combination of lower third-quarter GDP growth forecasts and elevated inflation readings (i.e., CPI, PCE Price Index), there has been an uptick in the number of stagflation prognostications. An economy that experiences high price levels in conjunction with weak growth for a prolonged period aligns with the classic definition of stagflation. In our opinion, stagflation fears are being overblown and the slower growth patch is mainly a function of the spike in Delta variant COVID-19 cases, which are starting to dissipate (see Chart of the Week section). In addition, we continue to believe that many of the factors that have led to higher prices, such as significant monetary and fiscal stimulus, labor shortages, logistical disruptions (supply bottlenecks), and supply/demand imbalances will likely dissipate over the next few quarters as the effects of the pandemic begin to fade. Overall, we don’t think that stagflation headlines warrant alterations from an asset allocation standpoint.
- Bank Earnings Season Commences – JP Morgan, often viewed as a bellwether within the financial services industry, released its third-quarter earnings last Wednesday. Results exceeded consensus estimates but were aided by the release of excess reserves (credit provisions) and income tax benefits. Even after stripping away the non-operational boost to earnings, results across various business segments were typically in-line or better than consensus estimates. While loan growth is still not robust, the company believes it has stabilized and is poised to accelerate, barring unforeseen changes to the economic backdrop. We will continue to monitor earnings reports from other Financials to see if they corroborate the “worst is behind us” narrative. The Financials sector has outperformed thus far in 2021, and we would not be surprised to see some profit-taking and short-term weakness. That said, we don’t envision material changes in our Financials exposure given our expectation of higher interest rates and solid economic growth.
- Global Interest Rates on the Rise – Since early August, the sharp upward move in interest rates has not been limited to U.S. fixed income markets. The 10-year yield for German government bonds is on the verge of going positive, while the interest rate for 10-year U.K. government bonds has been at the highest levels since 2019. Higher rates have enabled more interest rate sensitive stocks, like Financials, to outpace more defensive market areas such as Utilities and Health Care. Higher yields have also coincided with industrial metals (copper, nickel) outpacing precious metals (gold). Also, higher beta stocks have started to outperform their lower beta counterparts after several months of stagnation. We have no visibility as to how long this trend will persist but believe that taking a more defensive posture is not warranted at this time.
|Russell 1000 Value||(5.1)||16.6||19.9||11.10||10.11||1.90|
|Russell 1000 Growth||(3.7)||22.7||27.0||28.45||24.89||0.64|
|MSCI EM (Emerging Markets)||(2.1)||(2.9)||2.6||10.09||10.28||2.24*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||1.0||(1.2)||(0.7)||5.55||3.75||1.68|
|Bloomberg Barclays US High Yield – Corporate||(0.1)||3.5||5.3||7.45||6.33||4.74|
|Bloomberg Barclays Municipal Bond||0.3||1.4||2.0||5.10||4.47||1.11|
|Bloomberg Barclays Global Aggregate x US (Country)||1.6||(5.9)||(4.1)||3.73||3.20||1.01|
|Crude Oil WTI (NYM $/bbl) Continuous||(16.4)||35.1||47.2||8.8||5.1||65.6|
|Natural Gas (NYM $/mmbtu) Continuous||(16.7)||68.6||47.8||(2.6)||4.0||4.3|
|Gold NYMEX Near Term ($/ozt)||(0.1)||(5.9)||(1.8)||13.4||8.8||1,781.6|
|Copper Cash Official LME ($/mt)||(2.9)||23.6||25.2||15.3||10.6||9,571.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.12||1.22||1.20||1.13||1.06||1.13|
|Japanese Yen per U.S. Dollar||115.45||103.25||104.49||113.55||114.41||112.97|
|U.S. Dollar per British Pounds||1.33||1.37||1.34||1.28||1.26||1.33|
Chart of the Week: Improvement on the COVID-19 Front
- The first chart illustrates the recent decline of U.S. COVID-19 cases based on a seven-day rolling average. In late August, fears about the potential impact of the Delta variant intensified, which prompted many government officials to implement vaccine mandates. Since then, daily COVID-19 cases have fallen roughly fifty percent from peak levels, and hospitalization and death rates have also continued to decline. While we are not out of the woods yet, the recent data is encouraging. The combination of vaccine distribution and potential immunity brought about by prior infections seem to be curtailing the spread of the virus.
- The second chart shows the impact the Delta Wave has had on the U.S. labor market. Based on data compiled by Cornerstone Macro, the rise in COVID-19 cases led to a reduction in the workforce, which in turn negatively impacted consumer confidence. According to Cornerstone Macro, there’s a 60% inverse correlation between COVID-19 cases and consumer confidence, assuming a one-month lag in the data series. An argument can be made that the slower GDP growth this quarter is at least partially attributed to the disruption in the labor market and waning consumer confidence. Assuming no further uptick in cases, we expect stronger growth in the fourth quarter as consumer confidence improves and foot traffic within the leisure/hospitality industry climbs higher.
Commentary: Energy Prices on the Rise
The table below shows the prices for various energy resources as of last Wednesday. As you can see, gasoline and oil (WTI) prices have hit their highs for the year and are materially above the averages seen over the past five years. The impact of elevated energy prices on GDP growth is difficult to quantify, given that the boost in energy-related capital expenditures (additive to GDP) would partially offset the reduction in consumer spending. However, the effect on consumer sentiment, which is even more fickle and difficult to gauge, could be more detrimental to GDP than forecasted by many economists.
On a positive note, if oil prices were to remain slightly north of $80 a barrel for the remainder of 2021, energy-related expenditures would still be below the levels experienced during the first few years following the 2008/2009 Financial Crisis. In addition, energy costs as a percentage of Disposable Personal Income (DPI) would still fall short of average levels experienced over the past 45 years, even if oil prices were to remain within their current vicinity.
One thing to note is that higher energy costs have disparate effects based on income levels, with individuals within the lower income brackets bearing the brunt of the increased costs. COVID-19 related fiscal spending has boosted the savings rate to just under 10% and should help to cushion the blow to some extent.