By Pete Biebel, Senior Vice PresidentPrint This Post
One old idiom that seems to be a good fit for the market’s current state of mind is “waiting for the other shoe to drop.” That saying apparently dates back to the early 1900s and originated in boarding and rooming houses of the time. When an upstairs neighbor dropped one of their shoes, a second unwelcome thump was sure to follow. The implication of that mindset is that an expected and inevitable event is about to occur; and the event is most often negative.
A little over a year ago, the market was skewered by the stiletto of the Covid pandemic. When that shoe dropped, the world was at a loss about how to react to the potential economic damage. Initially, all markets (stocks, bonds, commodities) were shaking in their boots; everything sold off. In response, Congress and the Fed opened the liquidity taps. With the pumps running at full speed, the markets made a flip flop and began a year-long rally. For the next six months, the high-heeled mega-cap companies that benefitted most from the work-from-home paradigm were the leaders, while industrials, financials, materials and energy stocks were the loafers.
The market got a new pair of shoes late in 2020. News of a couple effective Covid vaccines was like a pair of ruby slippers for the market, but it wasn’t the sole catalyst. The November election results, and the promise of massive additional stimulus packages enhanced the optimism for a recovery and a return to normal. That optimism brought higher commodity prices, the threat of inflation and higher interest rates. That combination in turn brought weakness to the high-growth stocks that had been leading the market and new-found strength in those sectors that had been lagging.
Year-to-date, the strongest U.S. equity sectors have been Energy, Financials, Real Estate and Basic Materials. Non-equity sectors like Commodities, Base Metals and Agricultural Commodities have outperformed most of the equity sectors. Last week, the Energy sector was a shoo-in for best performer with a gain of nearly 7%. The Real Estate sector was next-best, climbing about 3%.
Last week, big gains on Friday saved the week for the broad averages. The employment numbers that morning were apparently just the right mix of not too hot and not too cold. The Dow Jones Industrial Average (DJIA), the NASDAQ Composite Index (COMP) and the S&P 500 Index (SPX) all ended Friday with minor net gains for the week of between about 0.5% and 0.7%.
As the averages rallied through late-2020 and early-2021, the concern was how much of the coming economic recovery had already been priced into the market. Recent activity has been suspiciously flat. Through much of the past several weeks, the averages churned in narrow range days a bit below their record highs. SPX seems stuck at roughly the same price level that it first reached nearly two months ago. COMP has even bigger shoes to fill as it has been mired in a range about 3% below its February and April highs. This recent relative dullness, coming amidst generally favorable economic data and earnings reports, suggests that the market seems to be fearing that another shoe is about to drop.
The anxiety revolves around the Fed’s tapering and whether higher-than-expected inflation might force the Fed to act sooner than it currently plans to. And, the huge current and future fiscal deficits could eventually force interest rates higher despite the Fed’s wishes. With some inflation certainly coming and with the potential for higher rates increasing, the market’s current equilibrium state may be an indication that it’s trying to determine whether the next shoe that drops is going to be a ballet slipper or a combat boot.
As we wait for the thump, now could be a good time to discuss with your advisor what actions if any you might contemplate depending on what scenario unfolds. If the market reacts too steeply to inflation news, it could present buying opportunities in some of the beaten down growth stocks.
As I have written over the past couple months, I am skeptical that the averages can climb much higher without a more extended timeout. The first short-term sign of trouble that might occur would be taking out last Thursday’s lows on COMP and SPX. COMP’s low that day was 13,549. Sustained trading below that level would mean that COMP had again dropped below its 50-day moving average. The more critical area for COMP on a longer-term basis is in the 12,700 – 13,000 range. That’s an area between the early-May lows and the rising 200-day moving average.
The 50-day moving average on SPX is down around 4140, or a little more than 2% below Friday’s close. But declining below that level would be a double whammy for the index. Not only would it fall below the 50-day, but it would also be the first significant break of a seven-month uptrend off the late-October low.
Thursday morning’s reports on Initial Unemployment Claims and CPI are the two big events on the economic calendar. They may take on extra significance this week in light of next week’s Fed meeting.
|Monday 6/7/2021||Consumer Credit, April, M/M||$25.8B||$20.0B|
|Tuesday 6/8/2021||International Trade, Trade Deficit, April||$74.4B||$69.0B|
|JOLTS Job Openings, April||8.123mm||8.045mm|
|Wednesday 6/9/2021||Wholesale Inventories, April, M/M||+1.3%||+0.8%|
|Thursday 6/10/2021||Initial Jobless Claims||385K||369K|
|Consumer Price Index, May, M/M||+0.8%||+0.4%|
|CPI ex-Food & Energy, May, M/M||+0.9%||+0.4%|
|Friday 6/11/2021||Consumer Sentiment, June||82.9||84.0|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.