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One Step Forward, Two Steps Back

By Ben Norris, Securities Research Analyst, Associate Vice President

Trading last week was oddly similar to the week prior, with markets suffering losses early in the week before eventually recovering some ground on Thursday and Friday. Wednesday was the outcast of the week, as the session that showed the most significant volatility, trading down sharply at the open and slightly trimming losses by the closing bell. By Wednesday afternoon the S&P 500 (SPX) and Dow Jones Industrial Average (DJIA) were down roughly 1.5% while the NASDAQ Composite Index was down around 1%. Thursday and Friday were relatively uneventful sessions as stocks pared Wednesday’s losses and quietly marched toward the weekend.

Once again Information Technology stocks had a volatile week, but the eventual outcome was vastly different versus the week prior, in which Tech stocks were down sharply. The sector was able to finish in slightly positive territory showing a 0.26% gain following the late week recovery. On the other hand, recent winners in the Energy, Industrials, and Materials sectors reversed course and traded off for the week, notching losses of 2.49%, 1.61%, and 1.49%, respectively. Stocks in the Real Estate, Healthcare, and Utilities sectors were the best performers as investors moved their portfolios into more traditionally defensive positions as concerns about inflation and the Fed’s plans for future monetary policy continue to linger. Net for the week, SPX showed a 0.43% loss, DJIA fell 0.51%, while COMP was able to eke out a 0.31% gain.

Inflation remains the name of the game for anyone keeping an eye on the markets. More specifically, the focus is whether the Fed will alter its policy as improving economic data creates pressure for the central bank to make a move to get ahead of inflationary pressures. Friday saw manufacturing activity (as measured by the Purchasing Managers’ Index) rise to its highest level in over a decade. Demand for goods and services is expected to remain strong as vaccinations mount in the U.S. and consumers get more comfortable returning to their old routines. In fact, manufacturers are experiencing such strong demand that they’re finding it difficult to secure the necessary raw materials and labor to deliver on the high level of orders received.

The disparity has continued to push the price for materials and labor higher. A broad basket of commodities has seen its price rise nearly 24% in 2021 amid strong demand. Similarly, the S&P 500 Materials sector has risen almost 20%, making it the third best-performing sector year-to-date. The companies that make up the sector are generally able to capitalize on higher commodity prices by passing on those costs to customers.

From a labor perspective, conditions are similar. Businesses, particularly large ones, have responded to difficulty in finding employees by raising wages. It seems each week another large corporation is in the headlines with a commitment to improving their average hourly pay as they struggle to staff up in anticipation of a continued economic recovery. Earlier in the week Initial Unemployment Claims decreased to 444,000, their lowest reading since the coronavirus pandemic began. The employment picture is expected to improve further as several states end $300 enhanced unemployment payments sooner than previously expected. Employers in the construction, hospitality, and retail industries are especially struggling to find enough workers to implement their reopening plans. The ceasing of payments is being framed as an effort to prod workers back into the labor pool, which will likely add fuel to the fire that is wage inflation.

As highlighted last week, inflation is a sensitive topic for the market with valuations near all-time highs. If inflation eventually forces the Fed’s hand and they taper asset purchases (a possibility they teased last week) or raise interest rates, the market’s reaction will almost certainly be aggressively bearish. We find ourselves in an interesting if not paradoxical position. If future economic data disappoints, investors are reassured that the Fed will continue its accommodation, and the market can remain comfortable with nose-bleed valuations. On the other hand, if economic data continues to improve, investors are afraid that Fed accommodation goes away (interest rates rise), and the market might reconsider if it’s appropriate to pay such rich prices for stocks.

This is where this week’s report title comes into play. The market is walking a fine line between economic data just disappointing enough that we get to keep our precious low interest rates versus data so positive that the rug gets pulled out from under the market and valuations experience a correction to more rational levels. In other words, one step forward toward economic recovery could mean two steps back for stocks.

First-quarter earnings season is pretty much over at this point and those that have yet to report shouldn’t have much sway on the market. The coming week is relatively light on economic data ahead of the Memorial Day holiday next Monday. However, there are some important readouts for the inflation picture. An update on home prices on Tuesday will provide a look into one of the primary drivers of inflation so far this year. On Thursday, Initial and Continuing Jobless Claims could cause some waves if they build on last week’s improvement. Finally, on Friday, Core Inflation will be closely watched. A higher-than-expected number will mean all eyes on the Fed as they play chicken with an economy that runs the risk of overheating.

Date Report Previous Consensus
Monday 5/24/2021 None scheduled
Tuesday 5/25/2021 Case-Schiller National Home Price Index (Y/Y) 12%
Consumer Confidence Index 121.7 119.5
Wednesday 5/26/2021 None scheduled
Thursday 5/27/2021 Initial Jobless Claims 444K 425K
Continuing Jobless Claims 3.75M 3.64M
Durable Goods Orders (April) +1% +0.7%
Friday 5/28/2021 Core Inflation +0.4% +0.6%
Consumer Sentiment Index 82.8 83.0
Consumer Spending +4.2% +0.4%

 

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