By Pete Biebel, Senior Vice PresidentPrint This Post
An already extended market ventured a bit further out on its limb again last week. The promise of the sweet fruits of a rebounding economy has tempted the market’s appetite and has inveigled investors to stretch even further out on the valuation branch. Leafing through last week’s economic reports, there are many reasons for the expansion of that budding optimism: The increase in Retail Sales in March was much larger than expected; Initial Jobless Claims were the lowest in a year; and both Housing Starts and Industrial Production came in above consensus expectations.
The major averages all logged gains of a little over 1% for the week. The S&P 500 Index (SPX) was in the green virtually all week and notched a 1.37% net gain. Both the Dow Jones Industrial Average (DJIA) and the NASDAQ Composite Index (COMP) fell briefly and modestly early in the week before lumbering higher to net gains of 1.18% and 1.09% respectively.
Again last week, stocks seemed to have the benefit of cross-pollination from the strengthening bond market. In last week’s article I theorized that some of the stock market’s late-week strength in the prior week was a direct result of the bond market holding up well even after the Producer Price Index report that morning came in much stronger than expected. That omen of higher inflation ahead might have caused interest rates to spike higher; when it became evident that the bond market was able to slough off that threat, stocks rallied.
Last Tuesday’s report that the Consumer Price Index for March jumped much more than expected reintroduced the inflation threat. The 10-Year Treasury yield spiked to near 1.7% on the news, but that was its high for the day and the week. The 10-Year yield gradually wilted through the day and ended the session near 1.63%, below where it had begun the week. Two days later, on Thursday, that yield fell as low as 1.53%, its lowest level in more than a month.
Perhaps the bond market has turned over a new leaf. From January into mid-March, the 10-Year yield shot up from 1.00% to 1.75% as the bond market feared that a new scourge of inflation was about to blossom. In recent weeks, as economic data has confirmed that peril, the bond market treated it as just more barking at the moon. It apparently perceives that any green shoots of inflation in the near future will likely to be just a temporary phenomenon as opposed to a new evergreen condition.
The declining yields helped the interest rate sensitive Utilities sector to nearly a 4% gain last week, the best among the U.S. equity sectors. That advance lifted the S&P Utilities Sector Index to its highest weekly close in more than a year though it’s still about 4 ½% below its February 2020 high. The Real Estate sector was also near the top of that list, gaining about 2 ½% for the week. It, too, reached its highest level in more than a year and is now within about 1 ½% of its record high of early 2020.
More evidence that the market’s rally has been branching out over the past six months: Nearly every other sector had a positive week and nearly every other sector ended the week at record highs. The Communications Services sector was hobbled by continuing poor performance in some of the media companies that were central to the forced selling caused by losses of a very highly leveraged trader a few weeks ago. That sector lost a mere 0.1% last week, leaving it just a whisker below its record close of the prior week.
The one sector that is still considerably below its record high is Energy. That sector did manage to squeak out a 0.46% gain for the week, and it still leads all sectors with a year-to-date gain of more than 27%, but it has given back a big chunk of the previous four month’s gain in the past five weeks. The Energy sector saw its peak valuation about seven years ago. At its low of a year ago, it had fallen more than 70% from that high. It has enjoyed a significant rebound over the past six months as crude oil prices rallied from near $35 per barrel to near $70, but it’s still more than 50% below its record level. Thankfully, that sector now accounts for just a 2.6% weighting in the S&P 500.
Prices for Gold have been almost the mirror image of the ups and downs of the Energy sector. Gold peaked near $2000 per ounce last summer as the weaker Dollar and lower interest rates in the early months of the COVID pandemic were bullish for the metal. When those trends reverse, so did Gold. Over the next seven months, Gold fell back to near $1700. The weakness in the U.S. Dollar over the past few weeks along with lower interest rates have brought some of the luster back. Last week Gold rallied to near $1780, its highest level in nearly two months, lifting it back above its 50-day moving average for the first time in three months.
The knotty issue for the market is whether it has already priced-in all the good news to come. To repeat a few lines from last week, “We all know that everything is going to get better. Employment will continue to improve; GDP will grow rapidly; earnings will increase; everything’s coming our way. And, the market will continue higher, maybe. The trick will be to determine at what point the market has become too optimistic about the future.” Only time will tell.
The same extended conditions that I pointed out last week continue to persist. As of Friday, 96% of the S&P 500 component stocks were above their 200-day moving averages. That’s up from 93% on the previous Friday. SPX is now more than 41% above its 200-week moving average. It rarely gets further out on the limb than that. That doesn’t mean that the market has to turn lower, but it does strongly suggest that further broad gains over the next couple months will likely be pruned considerably from what they’ve racked up in recent months.
Keep an eye on two things in particular this week. With no new inflation statistics this week, there’s nothing to spook the 10-Year yield higher. If for some reason it bumps back above the 1.6% level, that could be a bad omen for stocks. Also watch the semiconductor stocks. As a group, they’ve been trading sideways for the past two weeks just below the group’s record high. All it would take would be a little spark for those stocks to resume their rally; doing so would help the Technology sector specifically, which would be a plus for the overall market.
The week brings a lot more earnings announcements as the new earnings season takes root. Many of the DJIA component companies will report this week, so any given day could see a big divergence in the Dow’s performance relative to the other big indices. Conversely, the list of economic reports has been trimmed considerably. The Initial Claims data on Thursday seems to be the only report that might possibly spark a market reaction.
|Thursday 4/22/2021||Initial Jobless Claims||576K||615K|
|Chicago Fed National Activity Index||-1.09||+0.58|
|Existing Home Sales, March, SAAR||6.220mm||6.205mm|
|Leading Indicators, March, M/M||+0.2%||+0.6%|
|Kansas City Fed Manufacturing Index, April||26||26|
|Friday 4/23/2021||PMI Composite Flash, April||59.1||59.5|
|New Home Sales, March, SAAR||775K||887K|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.