The Navigator | July 2021
The stock market posted another positive month in June with the tech-heavy Nasdaq outperforming the market by gaining 5.5% while little changed with the cyclical-heavy Dow. The S&P 500 advanced 2.3% in June with YTD return of 15.0%. The technology sector came in as the top performer, followed by energy, communication services and real estate while financial and material sectors lagged. Overall, a decrease in the long-term bond yields (the benchmark 10-year yield dropping below 1.5%) favored growth stocks by reducing the implied discount rate on future earnings. Lower yields coupled with a flattening of yield curve weighed on financials by threatening bank lending margins as banks tend to profit from larger spreads between short-and long-term rates. The energy sector benefited as crude oil increased by more than 20% in the second quarter driven by supply discipline, growing demand and upward travel trends.
A surprisingly hawkish outcome from the Fed Reserve’s June policy meeting unleashed massive immediate repositioning in the financial market, but did not change our cautiously bullish market outlook. Thirteen of eighteen Fed officials see the first rate hike occurring by the end of 2023. The dot plot now shows two rate hikes in 2023, but it’s not clear how aggressive this tightening cycle will be, as it depends on how much of an inflation overshoot the Fed will allow. Given the recent mixed labor market data and the unemployment rate still as high as 5.8%, we don’t expect the Fed to announce its tapering until September and think the actual tapering might not start until 2022. We believe one of the following scenarios is likely to occur:
The recent data confirms that the economic recovery is still in good shape. The ISM manufacturing index continued to increase, and the consumer confidence index rocketed more than expected to the highest level since February 2020 as consumers’ concerns over inflation eased and spending plans picked up. Labor market data was mixed with payroll gains falling somewhat below expectations and weekly jobless claims remaining well above the pre-pandemic average. The lackluster employment data, however, helped to calm market fears about an overheating economy and potentially persistent inflation.
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↓ Valuation | With market ending modestly higher this month, valuations for equity improved marginally, but still appear overvalued. P/E ratios decreased to 29.8 at the end of May from 29.9 at the end of March. Forward P/E ratio also decreased slightly. Inflation adjusted valuation metrics continued to be negative with inflation rising.
↑ Sentiment | Consumer sentiment dropped in May with inflation fears as the University of Michigan consumer sentiment index came in at 82.9, down from 88.3 in April. Confidence is under pressure with stimulus starting to fade and gasoline prices moving higher, but wealth remains healthy with massive saving, decreasing debt and accelerating housing price. PMI index fell slightly, but remains elevated above 60.
↑ Technical | Technical indicators remain positive but look stretched. At the end of April, the S&P 500 was 12% above its 200-day moving average, 5% above the 100-day average and 2% above the 50-day average. Volatility spiked with VIX index reaching to 27.6 in the second week of the month, but came down and settled at 16.8, compared with 18.6 at the end of last month.
↑ Macroeconomic | Labor market continued to improve with weekly initial jobless claims fell for four consecutive weeks and reached closest to pre-pandemic level, though the payroll employment was weaker than expected. Industrial production rose 0.7% following a 2.4% gain in March. U.S. manufacturing seems to have weathered the global semiconductor shortage reasonably well and the near-term outlook remains favorable. Inflation remains risk with the core PCE price index increased 3.1% YOY.
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As of 6/30/2021. Data provided by Bloomberg, WSJ, NorthCoast Asset Management.
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