Downrange — Week of June 21, 2021

As of market close June 18, 2021. Returns in percent.

Downrange

Last week we wondered if the Recovery Race is over. We do believe vaccines and stimulus have the upper hand over the virus in the U.S. The India strain, or “Delta” as the WHO calls it, is still fighting it out in the UK and other parts of the globe. The stock market tries to price future corporate earnings and possible economic outcomes. Outperformance of Growth sectors over Value last week served as a “recovery complete” signal in our view. 

The Fed news helped close our book on the economic Recovery Race. The Recovery of the U.S. economy from government shutdowns is now over. Economic activity at the national level has recovered to levels of early 2020 and is embarking on Expansion. That is not a “boom” word, just an economist’s definition of more normal year-over-year growth. We do not want to return to “normal” growth of the 2010 decade, however. Much of that decade’s growth was a plodding 1.5% per year. 
 

What Said Fed

Three items stand out from last week’s Federal Open Market Committee meeting. First, a majority of Committee members believe two short-term interest rate increases will happen in 2023. Committee member Jim Bullard, President of the St. Louis Fed, stated Friday that he thinks the first increase could happen in late 2022. Second, the language regarding the pandemic has improved in each of the last two statements. This signals that the Committee sees the improving growth and rising inflation from reopening. Third, in his press conference Chairman Powell mentioned that the Committee will begin discussing the possibility of lowering their purchases of Treasury and mortgage securities. 

Committee member’s projections of a possible first increase in late 2022 and increases in 2023 show that inflation has their attention. Media headlines showed the projections as the Fed raising rates in late 2022. That is a misinterpretation of the projection’s “dot plot” graph. At most, it telegraphs to traders that members see a strong economy and slightly higher inflation numbers causing the Fed to act in a couple of years. It is not a formal plan announced in a press release.

Inflation will not be “transitory in a couple of quarters,” nor will it rise to 1980s levels. Inflation, or changes in price level, are driven by the supply of money and interest rates. The Fed has kept interest rates very low during the pandemic by buying Treasury and mortgage bonds. Its purchasing efforts pushed bond prices higher, which lowers interest rates. These purchases also dramatically increased the cash in the banking system as the Fed created dollars to pay for the bonds. But much of this money has yet to make its way into the economy, as the Fed ordered these funds to be deposited back at the Fed or be used by the banks to buy more Treasury notes. 

The size and scope of inflationary cycles are influenced by demographics and national debt levels. In the 1980s U.S. family formation and consumption were on the upswing. Today births and family formation are falling. National debt was very low, allowing for debt-fueled growth. Today our national debt is at or above the size of our economy, and the drain of servicing the debt is a disinflationary force holding down growth. Over the coming months inflation should stay around 3% as supply chains get rebuilt and pent-up demand is worked off. Over the next several years inflation should drift lower toward 2% to 2.5%, staying higher than the last 10 years because of wage increases. 
 

Jog to Jolt 

Remember that June is one of the worst months of the year for stock performance. Somebody must be in last place. Friday’s triple witching day put the exclamation mark on stock performance for the month. Quarter-end portfolio positioning along with options expiration jolted most stocks lower by a percent or two. Each of the three Dow indices are in the red for June, with the recovery-oriented Transports faring the worst, -7% at Friday’s close. One quarter of the S&P 500 consists of growth-oriented technology stocks, and the sector helped the big index stay above water for the month. 

The late June jolt may stick around. Most index charts in the very short term are in downtrends, but all remain in their consolidation areas that date back to mid-April. Year 2 of a Bull cycle should see bumps along the way. Stocks are less than 4% below all-time highs, and earnings forecasts are improving. Any summer correction should be a buying opportunity.
 

Wrap-Up

There are no changes in our outlook. The Fed may have surprised some traders and the media last week with their projections, but their changes are all positive. GDP growth for 2021 was raised a half percent to 7% and inflation 3.4%. Growth remains strong, and interest rates will remain relatively low for the next several years. 

Stocks should continue to bounce in a narrow range waiting for second-quarter earnings season. Companies took advantage of the Fed’s interest rate cuts last year to borrow heavily and reduce their interest costs. A good portion of the cash raised is going to be spent on share buybacks. We are not always fans of financial engineering but buybacks do lend support to stocks. This week’s data points for May personal income, trade and inventories will firm up estimates for second-quarter GDP. We are looking for second-quarter growth in the 7% area. 
 

 
Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary's University School of Law. Follow him on Twitter here. Greg Kalb is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts from The University of Texas at Austin.

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