Daily Global Perspectives

The August CPI report came in yesterday morning below consensus at 0.3% versus the expected 0.4% month-over-month. Year-over-year, CPI remains elevated at 5.3%, but is now decreasing from last month’s print of 5.4%. Core CPI, which excludes volatile items such as food and energy, came in at 0.1% versus the expected 0.3%. Breaking down the components, transportation services were down as the delta variant led to hesitant travelers and decreasing airline fares. Used cars have been a big inflation talking point recently, but they may be peaking as price increases turned negative after five consecutive months of gains. Even though this report shows signs of slowing compared the last one, bottlenecks in supply chains will likely continue to keep inflation elevated for the next few months. The Federal Open Market Committee remains focused on the labor market and likely will not change its course. It probably will start tapering near the end of the year as inflation slowly dissipates.

Recent economic and corporate earnings data is supportive of more upward momentum in the stock market. In a prior blog I discussed how stocks are “climbing a wall of worry”. That is, there are so many problems to worry about, yet the market continues to go up.  Well, there are good reasons for this, and I call them the A-B-Cs of investing. Here they are for August, or the most recently reported period:

Confidence is a critical, but difficult to identify component of the capital markets and global economic system. For businesses to expand production by investing in new equipment or hiring people, they need to believe their efforts will yield a return above their cost of capital. Likewise, while the propensity for individuals to consume is driven by a host of factors, it is ultimately the benefits they expect to gain from certain purchases that should outweigh other opportunities they have for income or savings. In both cases, people’s confidence in the current state of affairs and views of the future matter. Because consumers account for approximately 70% of the U.S. economy, one could reasonably say that they matter most. It is therefore critical to keep a close eye on the status of the consumer.

As the latest reading from The Conference Board’s Consumer Confidence Index shows, consumers are somewhat less optimistic as of late, with August’s reading the lowest since February (Figure 1). Both the present situations and expectations indices were down. Concerns over inflation, the Delta variant and dimmer economic prospects seem to be weighing on consumers’ minds. There is also an ongoing shift in consumer spending from goods to services, some of which may have more elastic demand (e.g. vacations, dining out, etc.) and could be easier for consumers to cut should confidence continue to wane. But, a little context matters: while the last two readings have shown a less sanguine consumer, the Index is down from a fairly high level in June, and it is still substantially higher than where it started the year. Given that the economy and markets do better with a self-assured consumer, let’s hope they keep their spirits up.

My forecast for year-end for the S&P 500 index was $4500. It has now passed this target and risen to $4529. Does this mean the S&P 500 is overvalued? No, not really. The P/E multiple based upon my target price with my S&P 500 EPS forecast of $168 was approximately 26.5x. Now, with earnings surging after two quarters of reporting, the consensus EPS expectation is a whopping $202. If you apply these earnings to the same multiple, the expected price would now be $5410. I don’t change my annual forecasts but will for next year. Based on current EPS expectations, it appears the market has more room to run.

Within the next few months, there should be progress towards a deal on about $3.5 trillion of new fiscal spending over the next 10 years. Likely there will be discussion and compromise between moderate and progressive Democrats on how much they want to spend and how much they’re willing to increase taxes to pay for it. Although there likely will be a tax increase, it probably won’t be as much as the White House is implying, and probably will have a marginal effect on equity prices. One of the biggest concerns with such large packages is the amount of debt the United States is taking on, but the big issue with borrowing comes from when it occurs at real rates greater than zero. Since real rates are still below zero, the U.S. government will essentially be paying back less than it is borrowing at the moment. On another front, U.S. and China relations may get nasty as China remains behind on promised purchases agreed to during the phase 1 trade deal. This could lead to more trade rules between the two countries and could increase goods prices. We will be keeping a close eye on the development of all these events and any effects they have on financial markets.

As the central bankers of the world gather (live or virtually) in Jackson Hole, Wyoming, they have nothing on me at an extremely important event in Deer Valley, Utah. It is hard to be pessimistic while writing this blog, surrounded by the majestic mountains and birds singing. But there is an uneasiness within the financial professional community and their clients. The one big concern is that the U.S. government and its sibling the Federal Reserve are increasing the country’s indebtedness to seemingly reckless levels. The charts below tell the whole story, with vertical jump in U.S. debt to GDP at $28.4 trillion and the Federal Reserve’s balance sheet expanding to almost $9 trillion. Despite this, more spending is on the way and the Fed continues to increase its balance sheet at a rate of $125 billion per month.

Over the past few months, we have seen record economic and financial market growth. Inflation numbers are slightly higher than the Federal Reserve expected, and the S&P 500 is now over 100% higher than it was at the trough in March 2020. This has caused many investors to believe the Federal open Market Committee (FOMC) may start rolling back its asset purchasing programs sooner than expected, to avoid the risk of the economy overheating. I do not believe that this is what will happen. I think that the Fed will do its best to keep markets stable and follow market expectations. One reason I don’t think there is a need to pull up tapering is that consumer spending has been negatively impacted by the Delta variant and by expiring unemployment benefits. In July, retail sales dropped 1.1%, significantly below the expected drop of 0.3%. Additionally, Dallas Fed President Robert Kaplan, one of the most hawkish members of the FOMC, recently flipped his stance on the issue and now is saying that reductions in asset purchases might not occur for some time.

In the Global Perspectives mid-year update I stated, ‘Plummeting bond yields are a sign that the market does not believe in the Fed’s ability to navigate a “soft” landing while “taking the punch bowl away.”’ Both “soft landing” and “taking the punch bowl away” are terms of art the market uses to refer to the Federal Reserve’s actions as it seeks to stabilize the trajectory of the economy while diverting it from overexpansion. The Fed’s minutes, released on Wednesday from July’s FOMC meeting, showed members simply discussing the timeline and pace of tapering the Fed’s $120 billion/month asset-purchase plan, no action taken. The markets reacted badly, dropping over one percent for both the Dow and S&P 500. Conservative investors should rest assured that the bull market is intact, but also should expect and be prepared for storms. Risky investors might consider it prudent to rein in some of their more speculative bets. The current market action is a “shot across the bow,” a foretaste of what to expect when the Fed actually tapers and the real “taper tantrum” hits. Please read our conclusion in our mid-year outlook, “Economic Boom and Peak Inflation Cap Second Quarter 2021,” at https://advisors.voya.com/insights/blogs/global-perspectives/economic-boom-and-peak-inflation-cap-second-quarter-2021.

In the past two months, the S&P 500 has returned 6.3% while the MSCI Emerging Markets (EM) index has returned -6.0%, an outperformance by the S&P of 12.3%. The main drivers of this have been a growth rally — the S&P 500 holds a large weighting of mega-cap technology stocks — and a lot of regulation coming down on Chinese tech firms.

So far this year, the S&P 500 has closed at record highs on 44 different occasions. After so much good news this year — from companies recovering much faster than expected after the coronavirus crisis last year — investors are split, wondering if this can continue or if it’s time for this good run to end. The bulls focus on easy financial conditions, fiscal and monetary stimulus, reopening momentum from demand buildup, corporate earnings beats and fund flows. On the other hand, the bears are focusing on the Delta variant, whether growth has peaked, expiring Covid related measures such as eviction moratoria and expanded unemployment benefits, Federal Reserve tapering, supply chain constraints, inflation, weakness in commodities and overbought sentiment. I for one believe that all these factors will influence the market, making it trade somewhat flat and within bounds. We’ve seen some of this take place during the most recent earnings season: shares have barely reacted after large earnings beats, suggesting good news is already priced in. Conversely, the markets also have not reacted much on days when there were large increases in Delta variant cases. This is probably because many of the cases are appearing in states that are unlikely to lock down at all again. Additionally, as the Fed has stated and recent experience has shown, the economic effect from each successive wave of Covid gets weaker.