The Navigator | November 2021
October marked a stock market rebound from September’s decline, with both the S&P 500 and Nasdaq clinching their best month since November 2020 by gaining 6.9% and 7.2% respectively. The Dow also rose 5.8% for its best month since March. The market climbed to a record high as solid third-quarter earnings overcame investors’ worries over moderating growth and lingering high inflation.
The concern of “stagflation” is mounting this month as the U.S. headline inflation rose more than forecasted in September while economic data showed peaking growth. The Consumer Price Index rose 5.4% in September YOY, reflecting the surging energy price and higher rental inflation. At the same time, both survey-based and market-implied inflation expectations hit multi-year highs, with the University of Michigan’s 1-year inflation expectation climbing to 4.8% and 5-year breakeven rate rising from 2.4% in late September to 2.9% at the end of October. However, in our view, the 1970-style stagflation worries are overblown for at least the following reasons:
First, this year’s inflation surge is primarily driven by the economic restart and global supply chain disruptions from the pandemic shutdowns. This month, we have seen emerging signals that the supply-chain bottlenecks may be easing, suggested by the tentative sign of peaking global shipping cost as well as data from warehousing sectors. The declining global COVID cases seem to be the contributing factor for this encouraging development. We expect the supply issues to ease next year as vaccine rollouts and natural immunity allow global businesses to adjust even better to the pandemic, moderating inflation and supporting growth.
Second, we believe the global economy still has room to grow and is far from a stagnation scenario. Although quite a few economic and producers sentiment indicators have been moderating recently, they are still at elevated levels versus historical data. For perspective, the recent moderation has followed record-high readings earlier this year. As long as the COVID infection risks remain relatively low, we expect the growth outlook remains constructive, boosted by high household demand, still accommodating monetary and fiscal policy as well as solid corporate earnings.
Third, during the 1970s, the Fed kept the interest rates low for too long before raising them to double-digits2. However, the Fed nowadays has learned its lessons over the years, and it has full tool-kits to address the risk of high inflation in a gradual and well-communicated way.
One effective way to gauge stagflation–high inflation and high unemployment, is using the Misery Index – an indicator constructed by combining the inflation and unemployment data. The Misery index stood around 10.2 in October, only half of the level compared to what we witnessed in the 1980s. We believe that the unemployment rate will continue to fall as more workers will be able to re-enter the market with receding COVID cases and dwindling effects of government unemployment benefits.
This month’s economic data were mixed. U.S. GDP slowed to a disappointing 2% in the third quarter after impressive growth of 6.7% in the second quarter, as consumer spending moderated with the resurgence of the Delta wave and Federal government spending fell as fiscal support shrank. However, we believe that the GDP data only offers a backward-looking view of the economy despite its wide-ranging coverage. On the positive side, job growth showed signs of reacceleration, with both initial and continuing jobless claims falling steadily over the past four weeks. Retail sales in September also surprised to the upside with total sales up 0.7% from August.
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↓ Valuation | With the S&P 500 rebounding in October and gaining 6.9%, valuations for equity are still under pressure despite recent solid earnings reports from a majority of companies within the S&P 500 index that have reported earnings so far. P/E ratios increased to 25.9 at the end of October from 24.3 at the end of September. The Forward P/E ratio also rose slightly to 21.9 from 21.3. Inflation-adjusted valuation metrics continued to be negative with inflation rising.
↔ Sentiment | PMI index edged higher to 61.1 in September from 59.9 in August. However, most of the gain was due to an increase in supplier deliveries, reflecting the longer delivery time primarily caused by the global supply chain issues. Consumer sentiment indicators were mixed with the Conference Board Consumer Confidence Index improved, while the University of Michigan’s sentiment index dropped marginally. We expect consumer sentiment to be boosted soon by the continuing recovery of the labor market and declining COVID cases. NAHB Housing Market Index rose to 80, accelerated by the fueling demand. However, the housing market still faces the challenges of affordability, supply-chain bottlenecks, and rising rates.
↑ Technical | Technical indicators remained positive but looked stretched. At the end of October, the S&P 500 was 9% above its 200-day moving average, 5% above the 100-day average, and 3% above the 50-day average. After a volatile September, volatility remained subdued this month, as investors welcomed a batch of strong third-quarter earnings reports and digested mixed economic news. The VIX level settled at 16.3 at the end of the month, compared with 23.1 at the end of last month. The short-term reversal signal, however, turned negative with the recent market gains.
↑ Macroeconomic | The preliminary estimate of the third quarter GDP slowed to 2%, with the net export, fixed residential investment, and federal government spending being the biggest drags. September payroll employment disappointed again with only 194,000 gains. However, the high-frequency initial jobless claims data have been steadily declining for four consecutive weeks in October. CPI rose 0.4% in September, a slight acceleration from the 0.3% gain in August. We expect the inflationary pressure to linger for a few months, mainly due to the global supply-chain issues. On the other hand, PPI increased 0.5% in September, slightly lower than the 0.7% increase in August.
Important Disclosure Information
As of 10/31/2021
1 Source: Bloomberg, WSJ, NorthCoast Asset Management.
2 Source: Federal Reserve History, “Volcker’s Announcement of Anti-Inflation Measures.”
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