In this week’s Monday Market Insights, we discuss the recent volatility in the stock market, China’s troubled property developer Evergrande, and the latest developments in Washington. In the chart of the week, we highlight an opportunity in small-cap stocks, and finally, we discuss corporate fundamentals heading into 2022.
Top Weekly Themes
- The “Average” Stock. Most stock market indexes are market cap-weighted, meaning the largest companies account for the lion’s share of index level price changes. For context, the largest five companies in the S&P 500 account for over 20% of the index. With the S&P 500 index still close to all-time highs, it may come as a surprise that the average stock in the index is down about 12% from its highs. Therefore, the long-awaited market correction has already happened for many companies, even if not reflected at the index level.
- One Evergrande, Please. No, Evergrande is not a new size coffee at Starbucks. Before last week, even many professional investors were unfamiliar with the highly indebted Chinese property giant. In summary, Evergrande is a Fortune 500 homebuilder in China that fueled impressive growth with extreme levels of debt. The company has over $7.4 billion of bond payments due in 2022 alone, and it has become increasingly clear that it does not have the capacity to meet those obligations. That said, Evergrande is not Lehman Brothers. It is not 2008. There is not the same interconnectivity with the global financial system, as debts are mainly owed by Chinese banks. Large U.S. banks all have less than 1% of total assets exposed to China and Hong Kong. The Chinese government will likely not bail out Evergrande, but it will step in to ensure financial system stability. Evergrande has $19 billion of international debt – for context, the U.S. Federal Reserve currently buys $120 billion in bonds EVERY MONTH.
- A September to Remember. The policy agenda in Washington heading into the fourth quarter is perhaps unlike anything we have ever seen. The most consequential negotiations will happen around the proposed $3.5 trillion spending bill, and new headwinds are emerging. Recently, Senator Sinema (D-Arizona) said she wouldn’t vote for a spending bill until the infrastructure bill is signed into law. Similarly, Senator Manchin (D-West Virginia) has suggested a “pause” that would put off consideration of the reconciliation bill until next year. We think this posturing will take months to resolve and ultimately result in a package much lower than the proposed $3.5 trillion.
|Russell 1000 Value||2.8||21.3||37.2||13.00||12.11||1.84|
|Russell 1000 Growth||5.0||20.8||31.8||27.30||24.52||0.66|
|MSCI EM (Emerging Markets)||3.3||2.3||17.6||12.96||10.10||2.24*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||(0.2)||(2.0)||(1.3)||5.51||2.93||1.67|
|Bloomberg Barclays US High Yield – Corporate||0.3||4.4||9.5||7.19||6.27||4.17|
|Bloomberg Barclays Municipal Bond||(0.0)||0.7||2.8||5.27||3.46||1.15|
|Bloomberg Barclays Global Aggregate x US (Country)||0.6||(5.6)||(2.1)||3.70||1.92||1.05|
|Crude Oil WTI (NYM $/bbl) Continuous||2.2||69.9||100.8||6.0||9.7||82.4|
|Natural Gas (NYM $/mmbtu) Continuous||(7.6)||101.4||82.0||16.1||9.9||5.1|
|Gold NYMEX Near Term ($/ozt)||0.6||(6.5)||(7.2)||13.0||6.9||1,769.7|
|Copper Cash Official LME ($/mt)||11.1||37.6||57.7||19.8||18.1||10652.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.15||1.22||1.18||1.15||1.10||1.16|
|Japanese Yen per U.S. Dollar||113.61||103.25||105.47||112.50||103.31||114.27|
|U.S. Dollar per British Pounds||1.36||1.37||1.30||1.30||1.23||1.38|
Chart of the Week: No Love for Small Caps
- Investors piled into small cap stocks in early 2021. It became a very crowded trade.
- Somewhat predictably, this served as a contrarian indicator. Small caps stocks have traded sideways for the better part of six months.
- Today, inflows into small cap stocks are historically weak. In the face of myriad risks (Delta variant, policy risk in Washington, a looming Fed taper), investors have abandoned the asset class in favor of the perceived relative safety of larger companies.
- As it did earlier this year, we believe this statistically extreme flow reading will serve as a contrarian indicator, making small caps an attractive asset class heading into year-end.
Commentary: Company Earnings Estimates Continue to Move Higher for 2022
Despite the laundry list of potential stumbling blocks and a persistent narrative of peak-growth, earnings estimates continue to increase for 2022. The average analyst estimate for 2022 S&P 500 earnings now stands at $222 per share. This is $5 higher than the average estimate reported in August. We believe the current economic expansion continues, and therefore corporate fundamentals can support an upward trending market. For perspective, consider this – investors are currently paying 24.5x last 12-months earnings when looking at the S&P 500. If this multiple holds and 2022 earnings are, in fact, $222 per share, that equates to 25% upside from current market levels. Even with some valuation compression next year (which we think is likely), the market can still move higher.
Furthermore, forecasted operating margins continue to make new highs. Historically, stocks do not face significant danger until margins begin to compress.