Top Weekly Themes
- Technology Stocks Struggle to Regain Footing. Although we try to refrain from making short-term market predictions, we are not terribly surprised that some of this year’s high-flying stocks are coming off the boil. Whether this weakness continues will largely be driven by confidence in a sustained economic recovery (a vaccine would help). Taking a purely data-driven approach, the mega-cap growth (tech) trade certainly has more room to the downside. For example, although the S&P 500 technology sector is down 11% from its peak, the sector remains 16% above its 200-day moving price average. Looking to individual companies, many examples remain even more extreme. Apple, which now accounts for almost 25% of the S&P technology sector, remains 31% above its 200-day moving price average…even after its recent 15% correction. Although we will continue to have meaningful exposure to these recent winners, we remain convinced that an underweight position relative to the benchmark not only reflects prudent risk management, but will lead to outperformance for patient investors.
- Interest Rates – Lower for…Forever? Last week, the Federal Reserve (Fed) continued to provide guidance related to the future path of monetary policy. To us, one thing was very clear. The bar to increase interest rates has been set at a level that will remain out of reach for many years. During his press conference, Fed Chair Jerome Powell said that an unemployment rate of 3.5% (pre-pandemic level) would be necessary to consider raising rates. As it relates to inflation, the Fed stated they would not tighten monetary policy unless inflation was on track to exceed 2% for some time. Current forecasts don’t predict inflation will exceed 2% until at least 2023. Similarly, the unemployment rate is projected to fall to 4% by 2023 (not consistent with the Fed’s stated goal). In our view, this means rates, especially on the short end of the yield curve, are likely to stay at current levels for the next 4-5 years, perhaps longer. The Fed Funds rate stayed at zero for seven years after the Financial Crisis, so there is certainly precedent for such a forecast. Investment implications abound, but the most critical may be the simplest – low rates give investors little alternative to stocks, perpetuating higher than average valuations.
- Retail Sales a Bit Soft. Retail sales data missed expectations last week, growing 0.6% month-over-month versus expectations for an increase of 1.0%. We also saw downward revisions to the July report. The continued improvement in retail sales is encouraging, but the pace of improvement is slowing. Consumer behavior has been somewhat inconsistent with the severity of the labor market decline, as income replacement via bolstered unemployment benefits allowed for a continuation of somewhat normal spending patterns. The combination of waning fiscal stimulus, still high unemployment, and a continued increase in the number for workers categorized as “permanently” unemployed, means this trend bears watching. As further evidence, credit card spending fell last month for the first time since the recovery began. In our view, confidence in a stable economy is critical for a sustained rotation away from growth/technology stocks into some of the unloved, value-oriented areas of the equity market.
|Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||2.0||(9.8)||(3.8)||11.8||43.0||2.60|
|Russell 1000 Growth||(0.3)||21.2||32.3||76.4||132.6||0.81|
|MSCI EM (Emerging Markets)||2.0||1.3||11.5||9.0||53.2||2.28*|
|Bloomberg Barclays US Aggregate||0.1||7.0||8.1||16.5||23.6||1.17|
|Bloomberg Barclays US High Yield – Corporate||0.1||1.5||3.8||14.7||36.2||5.48|
|Bloomberg Barclays Municipal Bond||0.1||3.3||4.8||12.9||21.8||1.31|
|Bloomberg Barclays Global Aggregate x US (Country)||0.6||5.6||6.3||9.7||20.8||0.75|
|Crude Oil WTI (NYM $/bbl) Continuous||9.8||(32.9)||(31.0)||(17.9)||(12.6)||41.0|
|Natural Gas (NYM $/mmbtu) Continuous||(12.1)||(6.7)||(23.5)||(32.5)||(23.0)||2.0|
|Gold NYMEX Near Term ($/ozt)||(0.7)||27.7||28.9||46.9||73.6||1,940.0|
|Copper Cash Official LME ($/mt)||0.8||9.8||17.3||4.7||25.9||6,761.0|
|1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.19||1.12||1.10||1.20||1.13||1.18|
|Japanese Yen per U.S. Dollar||106.18||108.68||108.21||111.05||120.91||104.72|
|U.S. Dollar per British Pounds||1.29||1.32||1.25||1.36||1.55||1.29|
As of September 17, 2020 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 7/31/2020.
Chart of the Week
- Although S&P 500 companies have issued a record amount of new debt in 2020, their interest expense over the last twelve months has decreased by almost $25bn since the third quarter of 2019.
- Over the next few years, this is welcomed news for companies that are still dealing with the impact of COVID-19. However, if interest rates were to increase, corporate interest expense would materially rise.
- The good news – rates seem unlikely to rise over the next few years (see Top Weekly Themes above) and more than 65% of new debt issuance has a maturity of greater than seven years.
Why we don’t believe runaway inflation is right around the corner
With interest rates poised to stay low for many years and the Fed continuing to purchase bonds (i.e. printing money) at a feverish rate, one might assume massive inflation is right around the corner. We are skeptical of this conclusion, for the reasons outlined below.
Although the Fed’s goal of higher inflation is clear, what is not clear is exactly how the Fed intends to achieve a persistently higher inflation rate. The Fed has been silent on this, other than reiterating the general commitment to use “the full range of tools” at their disposal. Those tools (both forward interest rate guidance and QE) are meant to accomplish the same goal: they keep interest rates low. The problem is that interest rates are already low, and everyone expects them to stay that way for some time. If rates are already low and expected to stay low, there is no incentive to shift borrowing and economic activity from the future to the present…pushing on a string, as they say.
The critical component that ultimately ignites inflation is not simply lower interest rates or the creation of new dollars, but those dollars entering and circulating in the economy. In reality, a dollar is “born” when a loan is made against collateral on a bank’s balance sheet, expanding the amount of total dollars in the system. And let’s remember what things like QE really are – an asset swap. The fed “prints money” and “un-prints” the bonds they are purchasing. So now the private sector (i.e. banks) has more cash to lend (or collateral with which to lend against). Banks are the ones that birth dollars into the system, the Fed is simply providing them collateral to lend against. Currently, with debt levels so high, the economy on shaky ground, and the yield curve so flat, the desire to lend and demand to borrow is such that these newly “printed” dollars aren’t finding their way into the system in a way that would ignite massive inflation.
As we see below, although Money Supply is way up, the Velocity of Money (or the speed at which money travels throughout the system) is plummeting. This is a headwind to inflation.