This week’s Monday Market Insights discusses recent near-term equity market performance, provides some thoughts about recent inflation data, and highlights some similarities in today’s interest rate environment compared to 2012. In our Chart of the Week, we highlight the recent supply bottlenecks and the impact on consumer prices. Finally, in the Commentary section, we assess whether the rapid rise in equity prices warrants more defensive positioning going forward.
- Equity markets pause – The S&P 500 Index hit a record high on September 2 and has since posted modest declines during most daily trading sessions. Overall, the magnitude of the pullback thus far, which was roughly 2% as of Wednesday, September 15, is relatively minor. In the past, we have commented about the duration and magnitude of the rally off the market low from March 23, 2020. It’s been more than 300 trading days since the S&P 500 Index has fallen back to its 150-Day Moving Average, a widely followed technical level. Based on an analysis conducted by Cornerstone Macro, there have only been eleven other times since the early 1940’s that the Index has not retraced its 150-Day Moving Average at least once over a rolling 12-month period. The subsequent average peak to trough decline was roughly 10% during these periods. On average, it took about 160 days for stocks to reach a new high from their prior peak. One thing to note is that these occurrences did not foreshadow prolonged bear markets and often occurred during the early phases of bull markets. We are not suggesting that a market correction is imminent but would not be surprised to see a retracement to the 150-Day Moving Average (about 5% below current prices).
- An update on inflation – Last week, the U.S. Bureau of Labor Statistics released Consumer Price Index (CPI) figures for August, which rose 0.30% from July, but were below consensus estimates. The month-over-month change was the smallest registered in seven months. The interest rate for 10-Year Treasuries fell slightly after the CPI news. Although one data point does not make a trend, the fact that CPI did not surprise to the upside gives some credence to those in the “inflation is transitory” cohort; we are also in this camp. Concerns about inflation are reflected in the latest findings from the National Federation of Independent Business, which cited that 43% of small businesses plan to increase prices over the next three months. This is the highest percentage since the late 1970s. Supply bottlenecks and labor shortages, which are factors that have led to higher prices, will likely ease over the next few months.
- Interest rates, a replay of 2012? – The interest rate environment over the last few months is somewhat analogous to the back half of 2012. Although there are some stark differences between the economic environment and political climate, a comparison can be made in terms of the absolute level of interest rates and the pattern of interest rate fluctuations. In 2012, 10-Year Treasury yields stayed within a range comparable to today before Congress reached a deal that prevented many proposed spending cuts (i.e., “fiscal cliff”) from going into effect. Today, Congress is wrangling over the details of a multi-trillion-dollar spending package. Maybe it’s a coincidence, but interest rates have been stuck in a range after previously accelerating as tensions flared over the “debt ceiling” and budgetary negotiations. At the end of 2020, we mentioned that interest rates would likely drift higher as the economy continued to strengthen as the worst of the COVID-19 lockdowns were in the rearview mirror. For rates to march considerably higher from here, political compromise will likely have to be reached. However, we don’t think the market environment justifies a material shift in our duration exposure, which is moderately shorter in relation to the benchmark.
|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: Supply Shortages Persist
- U.S. consumers may be perplexed as to why it’s more difficult to obtain certain goods and taking longer in terms of delivery times. Even multinational auto manufacturers like Ford/GM have indicated that part shortages are hampering vehicle production. The charts above may help to provide some context regarding the extent of supply chain bottleneck issues circulating around financial media. The first chart shows the number of container ships anchored offshore at one of the West Coast’s busiest seaports. There are roughly forty cargo ships that will remain stationary for up to eight days before being unloaded.
- The second chart shows container shipping costs, as measured by the Drewry WCI 40 ft. Freight Rate Composite. As you can see from the chart, freight rates are up nearly 600% since the end of 2019. Containerships account for a large percentage of the goods that are eventually transported inland by rail and truck. Various factors, including strong pent-up demand for consumer goods, COVID-19 related port closures, a shortage of freight containers, and trade imbalances, have led to a surge in shipping costs.
- Recent inflationary pressures have at least been partially attributed to rising shipping costs, which normally represent a small portion of the price for goods. Supply bottlenecks have created a logistical fiasco that may take a while longer to subside fully. However, we think that a combination of continued progress on the COVID-19 front, and a renewed demand for services coupled with less demand for physical goods, will likely lead to lower shipping costs and greater price stability.
Commentary: Is it time to play defense in the market?
Many investors are pondering whether now is the time to take a more defensive posture (reduce equity market beta) given the magnitude of the equity market rally and elevated stock valuations. While market corrections are always possible, we don’t think at this moment an overly defensive posture is warranted. One reason is that high yield credit spreads have continued to tighten. Lower beta, more defensive stocks tend to outperform as credit spreads are widening.
The recovery in corporate earnings has exceeded consensus estimates, and sell-side research analysts have continued to make upward revisions to earnings forecasts. The chart below shows that the percentage of upward earnings revisions for the S&P 500 Index constituents going back to 1985. The recent figure is at the highest level witnessed over this entire period. Earnings estimate revisions may have peaked and will likely decline going forward. However, barring a COVID-19 setback, we don’t foresee a material decline in earnings growth and earnings estimate revisions, which often coincide with favorable returns for more defensive sectors of the market.