The year-over-year CPI May headline gain surged to 5.0% and y/y core CPI to 3.8%, the largest gains since 1992. That, along with “blast-off” in the title, should have gotten your attention. So why is the 10-year U.S. Treasury yield continuing to drop to a 1.4 handle? Well, a week or so ago, we discussed the ending of the Federal Reserve’s “SLR” exemption, AKA, “stealth Fed tightening,” which has changed sentiment markedly and led to not only dropping yields but a strengthening dollar. The market has woken up to the fact that the Fed could stop inflation with a snap of its fingers, and inflation is a good thing until the “coast is clear” for the economy.
Since the Biden administration took office, it has mostly provided positive news to financial markets, specifically with the trillions of dollars in stimulus it has pushed for in the infrastructure bill and the American jobs plan. But we all know there is no such thing as a free lunch, and the upcoming increase in taxes is how these stimulus programs will be paid for. The most recent talks from the G7 signaled an agreement for a global minimum corporate tax rate of 15%. If this tax rate is imposed, the effect on overall S&P 500 earnings per share should be marginal, at about 1%. This impact will vary significantly by sector, however, with information technology and healthcare being the most affected at about 2.5% and 2.0%, respectively; energy should be the least affected, with an impact of about 0.2%. The semiconductor industry should see the biggest impact, as it comprises the largest number of companies that currently pay less than a 15% effective tax rate.
At Global Perspectives we try to make our research simple, yet sophisticated; call it “sophisticated simplicity.” I would put our A, B, Cs up against the top Wall Street research anytime. Here is an update of the latest data on the Global Perspectives A, B, Cs:
A – Advancing Corporate Earnings: as of May 28 Refinitiv calculates that S&P 500 actual 1Q21 earnings growth, compared to a year ago in 1Q20, is an astounding 52.5% ― more than double the expectation on April 1.
B – Broadening Manufacturing: The ISM Manufacturing report is staying near its high end, increasing from the prior month to 61.2. As part of this report new orders surged to 67.0 and backlogs, a rarely noticed datapoint, jumped to 89.6 ― which I believe is a record!
C – Consumers as the Gamechangers: U.S. initial jobless claims dropped below 400,000 for the first time since March 13, 2020. Retail sales busted through $600 billion ― the first time ever in a month ― in March 2021. I expect this Friday’s nonfarm payroll report to be a blockbuster, near one million new jobs, with the unemployment rate dropping to a five-handle.
My A, B, Cs are the most important data to track as they are the most influential, in my view. The good economic data keep rolling in.
After dropping sharply during April 2020 to under $20 per barrel, Brent crude oil is above $70 as of June 1, 2021. Most of the sudden price drop and quick rebound were due to changes in demand during 2020, from the economic lockdowns to a quick reopening a few months after. On the supply side, OPEC has been limiting the number of barrels it has been producing in an attempt to inflate prices and avoid over-production; but as reopening enters its final stages and society returns to normal, the potential diminishes for further oil-price increases.
Last March, the Federal Reserve massively eased policy rates and announced a temporary change to its “supplemental liquidity ratio (SLR)…to ease strains in the Treasury market.” It was way more than strains — the Treasury market was blowing up as I witnessed first-hand, watching yields plunge then spike in March 2020. The SLR was given until March 2021 and the Fed did not extend it.
In most cases, slowing down before colliding with a wall will reduce damage. This may not be the case, however, when it comes to economic momentum and the refinancing of maturing debt — a concerning situation towards which China appears to be heading without brakes.
Bitcoin, recently dubbed “digital gold,” is losing its luster at a breakneck pace. It has plummeted from an April 15, 2021 high of $63,480 and Thursday morning is being quoted at $39,270. This is a stunning loss of 38% — in about a month. Hmm, let’s annualize that! At least you can wear gold.
This year, as the ten-year U.S. Treasury yield has risen in 2021 from 91 basis points (bp) to 164 bp, a rotation of value outperformance also has occurred. Year-to-date, the S&P 500 Value index is up 17.5% compared to the S&P 500 Growth index up 6.0%, a difference of 11.5%. The rise in interest rates has benefited the cyclical sectors that have a higher weight in the value index such as financials, and economic reopening has significantly helped the industrial and energy sectors. On the other hand, the growth index has lagged this year because it has a 29% larger allocation to the technology sector than does the value index. Technology stocks have suffered because it is harder to justify the high P/Es of many of these firms, which invest in projects that produce cash flows significantly farther in the future than most other companies.
What is the difference between Walt Disney’s, circa 1943, Chicken Little yelling “the sky is falling” and the Chicken Little, circa 2021, yelling an equally adamant “inflation is rising”? Nothing, absolutely nothing — both are equally hysterical and comical. Some may point to April’s YoY CPI rise of 4.2% and this morning’s reported PPI YoY record high of 6.2% as proof that inflation is “not transitory.” The real anger at inflation has nothing to do with rising rates and everything to do with its impact on speculative, high P/E stocks. It crushes stocks like Tesla, which currently is sporting a price 567 times its expected earnings per share. What many investors fail to recognize is that the P/E multiple is a duration play; those who would never buy a long duration, 20-year U.S. Treasury bond are happy to buy a stock with a 567-year duration. Go figure.
One of the problems with high expectations is that they leave a lot of room for disappointment. So it was with Friday’s nonfarm payrolls report, which came in at about a quarter of the roughly 1 million job gains expected, leaving total payrolls a little more than 5% below where they were pre-pandemic. Despite the undershoot and uptick in the unemployment rate from 6.0% to 6.1%, the jobs report did entail some positive developments, as average hourly wages rose, along with the labor force participation rate. An increase in the number of people looking for work counters the notion that generous unemployment benefits are incentivizing people to not work. While it’s reasonable to assume giving people more money not to work may impact some people’s decision to find a job, those claiming unemployment insurance have declined since the beginning of March. Another factor at play is the apparent lack of skills needed to fill the available job openings, as indicated by the NFIB Small Business Job Openings Hard to Fill Survey, which reached a record high in April.