FIVE THINGS YOU SHOULD KNOW
5. Key Insight – [VIDEO] In this week’s video we introduce you to Jon Heideman, one of our newest colleagues. Jon is a very exciting addition to the team, as you’ll see, both for his tremendous experience and talent, but also his fun personality. [ARTICLE] We catch you up on the major influences on today’s markets, as well as some ideas for how to better position yourself for what’s ahead
INSIGHTS for INVESTORS
What’s Going On
It’s been a week that saw the S&P hit new all-time highs, and risk assets broadly rise around the world in what was also one of the busiest weeks for new data points for the market to digest. News this week centered around earnings season, a slew of economic data points and of course the latest out of the Fed.
When it comes to earnings season the good news keeps rolling from goliaths such as Facebook and Amazon, but just about everyone else as well. According to Credit Suisse, 84% of companies have beat this quarter’s earnings expectations (which were actually pretty high expectations), but just as importantly guidance from companies around the next few quarters remains very positive as well.
Economic data continues to come in strong as well as the recovery marches forward. This week news broke that the U.S. GDP grew by an annualized 6.4% rate as the reopening moved forward. On this note, I want to briefly mention a common concern I’ve been hearing about the ratio that looks at valuation of stocks to GDP to express a frighteningly high number and argue investors should flee stocks. While there is no question some parts of the market trade at a premium the problem here is the denominator (GDP) is artificially low after the shutdown of 2020. The reality, as this week’s data showed, is the economy is opening back much stronger than expected and one needs to be careful around their analysis to any end as things mean revert.
Another positive data point(s) from not just the U.S. but around the world that was called out by JPMorgan recently to demonstrate the growing strength of economic activity was the PMI data for both manufacturing and service sectors. They noted, “look at the April PMI data for the major developed market economies. Manufacturing and services PMIs came in at 63.3 and 50.3, respectively, for the euro area and 53.3 and 48.3, respectively, for Japan. While manufacturing activity continues to look robust, the continued recovery in services on the back of vaccination efforts and the gradual lifting of social distancing measures should lead to accelerating growth over the remainder of the year. Although Japan’s services PMI came in below 50 at 48.3, household spending on services continued to improve on a year-over-year basis, indicating that the service sector is indeed on the road to recovery. Similar to Europe and Japan, U.S. April flash PMI data came in above 50, with manufacturing and services PMIs rising relative to the prior month. Unsurprisingly, this improvement in economic data has coincided with solid earnings results, particularly among the industries hit hardest by the pandemic like financials and airlines … Broadly, an environment of accelerating economic growth and rising rates should support the more cyclical parts of the market, and reinforces our constructive view on both value and international equities.”
Goldman Sachs sees strong growth ahead as well, as the comment and chart below summarize. They stated, “We believe the strategic case for risk assets remains favorable, with ongoing support from: 1) economic reopening and normalization, 2) fiscal support, 3) pent-up savings, and 4) historically easy financial conditions. As we move into the post-COVID-19 world, we believe the recovery will be non-linear and the opportunity set highly idiosyncratic.”
The final big piece of information the market had to digest this week was the outlook from the Federal Reserve’s most recent meeting. The attention continues to grow as inflationary concerns continue to do the same. Nothing scares the market a whole lot more than the idea of the Fed losing control over inflation. Inflation should have the Fed’s attention more than their comments would make it appear it does. As JPMorgan summarized, “Consumer prices rose in March at their fastest pace in nearly nine years, with the headline CPI rising 0.6% (consensus 0.5%) and the core CPI, excluding food and energy, rising 0.3% (consensus 0.2%). The main contributor to higher inflation in March was gasoline prices, which rose +9.1% m/m. Notably, the report revealed a rebound in core services prices as the U.S. economy reopens, with food away from home increasing 3.7%, while “limited services meals” jumped 6.5% for the year. While the upside surprise in inflation was small, it could be important as it increases the odds that inflation, as measured by the personal consumption deflator, will remain solidly above 2% y/y from April of this year well into 2022. Fed officials have indicated that they expect PCE inflation to average around 2.4% y/y in 4Q21, but that they will regard increases later this year as likely transient. As shown in the graph, the PCE deflation has recently tracked headline CPI closely, and our estimate of the March PCE deflator is now 2.3% y/y. However, if inflation prints continue to run solidly above target, it could create some communication challenges for the Fed. As inflation is expected to rise over the next few quarters, the Fed will certainly be closer to its criteria for raising short-term rates, but more imminently, it will be closer to its criteria for tapering, which simply requires significant progress toward 2% inflation and maximum employment. Investors should continue to manage their duration of fixed income assets carefully and consider the possibility that tapering could happen sooner than the market expects.”
And yet, despite the evidence that inflation may be stronger than previously forecasted, Fed Chair Jerome Powell made it very clear that a significant reduction of the unemployment rate and consistent 2% inflation is needed before the Fed should/would consider tapering QE or raising rates, and stated that it's not time to even begin "thinking about thinking about" either.
Analyst Tom Essaye commented that “given the Fed’s very dovish policy stance, which was reinforced by Chair Powell on Wednesday, I think it’s helpful to start watching inflation expectations a bit more closely, because they will tell us, ahead of time and ahead of actual inflation statistics, if the market is starting to get worried the Fed is “behind the curve” on inflation.” Many such commentators also suspect that the full release next month of the minutes may show a rift in the mindsets between various Fed members.
What to Do with All This Info
So, what’s an investor to do with this story of strong earnings, strong data and strong inflation?
Investing never comes with an all-clear, and as we’ve said we think the best path forward for most investors over the intermediate term is to be willing to embrace a little more volatility to avoid genuine risk.
What would that entail?
We think one strong consideration is to continue to look at the dividend paying, and more value-oriented, parts of the equity markets while also reducing one’s exposure to low-yielding high duration bonds.
Not only are these equities trading at much more attractive valuations than many of their growth counterparts, they are also the most likely beneficiaries of the reopening. Furthermore, as the chart from Lord Abbett below shows, such equities are likely to be a much better source of income in general than many other types of assets, as well as a source for the growth of income to counter the effects of inflation on one’s cost of living
There are always challenges and fears to be faced as an investor, but so too there is always a path for the disciplined and diligent. Stay focused on the big picture and you’ll find many reasons to be optimistic.
Have a wonderful weekend,
Tim and team at TEN Capital