By Pete Biebel, Senior Vice PresidentPrint This Post
For months, the stock market has been expecting and pricing in the prospects for a steep economic rebound driven by effective COVID vaccines and the promise of a fat stimulus package. Those expectations have also factored into an outlook for higher inflation, and along with it, higher interest rates, which in turn has fueled the recent outperformance in value stocks at the expense of growth stocks. With a strong reopening economy on the horizon, stocks prices in sectors like Energy, Financials and Materials have tacked higher while the accompanying higher interest rates have taken some of the wind out of the sails of high-growth stocks.
Last week brought more of the same. Industrial, manufacturing and financial stocks in the Dow Jones Industrial Average (DJIA) rocketed higher on Monday while the big tech stocks that dominate the NASDAQ Composite Index (COMP) flamed out. DJIA held on for about a 1% gain that day; COMP lost 2.4%, closing just over 10% below its record high of a month earlier. It was the biggest single-day outperformance by DJIA over COMP since the market rebound last spring. The yield on Ten-Year Treasury Notes climbed to 1.594% that day, their highest yield in more than a year.
On turnaround Tuesday, that yield tumbled, giving back all of Monday’s increase and then some. COMP gapped higher, recovering all of Monday’s loss on the opening. By the end of the day it had gained 3.7% while DJIA barely finished in the green. The lower Ten-Year yield helped to fuel a buy-the-dip rush back into some of the big tech names. The S&P Technology Sector Index gained 2.7% that day.
The first of the highly anticipated inflation data was released Wednesday morning. Headline CPI was up 0.4% and Core CPI (ex food and energy) was up 0.1%. Both numbers were dead on expectations and both were just a tick above the previous month’s readings. If those numbers had come in too hot, they could have exacerbated the inflation fears. While the data wasn’t bad news, it certainly wasn’t great news. Stocks had a replay of the Monday action: DJIA gained 1 ½%, the S&P 500 Index (SPX) advanced a mere 0.6%, and COMP, again held back by weakness in tech stocks, ended the day with a tiny loss.
Thursday brought news that the European Central Bank planned to accelerate its bond purchases. Confirmation that the worldwide money pumping was continuing unabated pushed the Ten-Year yield down to 1.50% causing the overall market and tech stocks in particular to gallop higher out of the gate. DJIA ended the day with a 1.6% gain and its second new high of the week. SPX gained about 1%, but that was enough to finally lift the index above its old February 16th high. COMP tacked on a bit more than 2 ½% on Thursday, lifting it to within about 5% of its February 12th closing high. Thursday was also the day that President Biden signed-off on the $1.9 trillion stimulus package.
Perhaps because the massive additional fiscal spending had been confirmed, the Ten-Year yield spiked higher Friday morning, eventually hitting 1.64%, its highest level in more than a year. The three major averages all gapped-down on the opening. Based on the market response to higher rates over the past several weeks, it was no surprise that COMP was weaker on the day, down 0.6%, dropping its gain for the week to 3.1%. It was the first positive week for COMP in the last four. SPX was in the middle again, up just 0.1% for the day, but it still had a net 2.6% gain for the week. DJIA climbed nearly 1% on Friday to fatten its gain for the week to 4.1%.
Small-cap stocks in the Russell 2000 Index (RUT) are apparently perceived to be winners in the economic reopening and are apparently also unaffected by higher interest rates. RUT tacked on gains in every session last week, clearing its February record high on Thursday, for a total gain for the week of 7.15%. RUT’s YTD gain is nearly 19%; its total gain since the Friday before the election is now nearly 53%.
2021 will almost certainly be better than 2020. We should expect to see significant GDP growth in the next few quarters. No doubt, the enthusiasm about the reopening of the economy is running hot and the free-money fiscal and monetary policies are fanning the flames. Time will tell whether that enthusiasm is justified and whether the market has already priced-in all the expected future growth. How much of the free money will actually be spent as opposed to saved/invested? Will price inflation offset the hoped-for gains from increased spending?
Imagine the impact on asset prices if we could use Monopoly money to buy things like houses and stocks and crypto currencies. The combined fiscal and monetary policies have essentially created a similar impact. If you have any doubt, take a look at a chart of the money supply statistic “M2.” The nation’s money supply has certainly increased over time, but over the past twelve months, that increase has been nearly parabolic. Going forward one issue will be whether the economy can grow into the gains the market currently expects. But an even bigger issue will be at what point and to what degree will the Fed need to throttle back on its asset purchases or even, Heaven forbid, increase its short-term target rate. Perhaps an even bigger issue could be at what point political common sense will begin to restrain runaway spending.
The speculative excess in the big tech stocks has certainly cooled, some stocks in that sector with comparatively reasonable Price/Earnings ratios may now offer reasonable buying opportunities. After the run in RUT, it might be tough to find good bargains in small-cap stocks. My favorite targets for buy candidates now are in large, established companies with solid balance sheets that are in the lower end of their historic valuation ranges. On a call with our advisors a couple weeks ago I identified a half-dozen such companies, all of which also had a history of increasing their dividends annually.
With SPX climbing back above the 3900 level last week, any near-term concern over that index’s brief break below 3800 in the previous week has vanished. The major averages are not technically extended on a short-term basis; for DJIA and SPX, there’s no overhead resistance. And the free money pump will be sending another bundle of cash into the system soon. Still, on a longer-term basis the averages are extended. SPX ended the week 34% above its 200-week moving average; it rarely sees significant gains from that condition and is unlikely to now even with free-money. Rates can move a little higher and/or the indices can move a little lower without setting off any alarms. On SPX, the first key level below the market over the next week or two is the 50-day moving average, currently near 3841.
For the first time in a long time, the Fed policy statement on Wednesday could spark a market reaction. No big changes are expected to be announced. But even a little change in rhetoric or a bit of a bump up in some of the “dot plots” could spook the market. The large expect decline in the month-over-month Retail Sales data is likely due to the absence of the boost that January spending got from the $600 stimulus payments approved in December.
|Monday 3/15/2021||Empire State Manufacturing Index, March||12.1||14.8|
|Retail Sales, February, M/M||+5.3%||-0.5%|
|Retail Sales, February, ex-Vehicles & Gas, M/M||+6.1%||-1.7%|
|Import Prices, February, M/M||+1.4%||+1.1%|
|Export Prices, February, M/M||+2.5%||+1.0%|
|Industrial Production, February, M/M||+0.9%||+0.5%|
|Business Inventories, January, M/M||+0.6%||+0.3%|
|Housing Market Index, March||84||83|
|Housing Starts, February SAAR||1.580mm||1.579mm|
|FOMC Policy Announcement and Press Conference|
|Initial Jobless Claims||712K||718K|
|Philadelphia Fed Manufacturing Index, March||23.1||24.0|
|Leading Indicators, February, M/M||+0.5%||+0.3%|
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Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.