Five of Six Winning Weeks — Week of August 2, 2021

As of market close July 30, 2021. Returns in percent.

Five of Six Winning Weeks

Stocks wrapped up July on a dull note, with averages mixed to slightly lower. The Bull remains in place, however, as most indices have registered gains in five out of the last six months. The S&P 500 continues to set the pace, winning six straight. True, six months in a row is not a record, but emblematic of a strong market that has climbed repeated walls of recovery worry. 

Excellent earnings drove much of the action in a busy week. Early in the week saw new records. Wednesday’s Fed meeting and press conference brought some reassurances that the Fed was paying attention. Finally on Friday, month-end window dressing by portfolio managers pushed stocks lower.

Procter & Gamble’s and Caterpillar’s results were good examples of the Recovery quarter. Both beat revenue and earnings estimates and guided analysts to good results for the remainder of the year. Chevron and Exxon both beat on stronger than expected revenues. Chevron, like a number of S&P members, signaled renewed strength by resuming its stock buyback program. 

FAAMG were supposed to be the stars last week. While Apple posted excellent results, it along with Amazon and Facebook warned of lower growth rates ahead. Alphabet (Google) bounced back from last year’s shutdown quarter with a 61% revenue jump and Microsoft had its most profitable quarter. Overall earnings are continuing to blow through analysts’ estimates. 88% of the S&P 500 members have reported and are beating estimates by 19%. Earnings estimates for the rest of ’21 and ’22 are getting marked higher. Executives are citing higher costs and labor shortages, which may squeeze margins in the next couple of quarters.

Fed Maybe

Almost lost in the earnings fun was the two-day Fed meeting. Traders drew some comfort from the Fed’s statement that it is considering reducing its purchases of Treasury and mortgage bonds. The committee acknowledged for the first time that “the economy has made progress toward” maximum employment and price stability but has not made “substantial further progress.” Our sense of “substantial further progress” would be an announcement at the September or November meeting of reductions in bond buying in the first quarter of 2022. That would give the Committee at least two more job and inflation readings to consider between now and then. 

Gold bugs rue this month as the fiftieth anniversary of the death of the gold standard. In 1971 President Nixon gathered his cabinet at Camp David and decided to sever the link between the dollar and the price of gold. There is a lot of room for debate on how and when, but little on why. Spending by Congress in the 1960s had increased the dollars in circulation and the U.S. simply did not own sufficient gold to back the amount of dollars in circulation. The gold exchange standard had ushered in a new wave of global trade as part of the 1944 Bretton Woods Agreement. Since then, the global economy has operated on relative currency exchange rates, to varying degrees of success. We would commend readers to Jeffrey Garten’s Three Days at Camp David for an in-depth look.

Not So Fast

We have suggested recently that Peak is Past, and July’s early data suggests we may be on the right track. The first half of 2021 was probably the peak growth of the recovery and for many, the fastest growth in their careers. The headline GDP number for the second quarter was a disappointing 6.5%, well below expectations of 8%. Fear not, dear readers. 

The peculiarities of GDP accounting make inventory drawdowns and trade deficits a negative. The trade deficit rose thanks to greater import demand, cutting GDP by 1%. Falling inventories cut over 1%. So, the 8% level was there in activity, if not showing up in official stats. To drive the point home, consumer spending in the second quarter rose at an 11.8% annual rate (wow) and business fixed investment an impressive 8%. 

Looking ahead for the third quarter, flash July PMI indexes suggest growth in the U.S. and U.K. slowed slightly but remained at very strong levels. The rest of the world numbers come out this week. We expect the rest of the world to catch up to U.S. levels later in the year as lockdowns ease. The Chicago area PMI was notable, hitting its second highest level ever, 73.4 versus estimates of 64.6. Consumer confidence remains strong, an important leading indicator for spending. The University of Michigan inflation expectations gauge at one year sits at 4.7% and for five years from now, 2.8%. The one-year number strikes us as increasingly likely as housing prices take at least a year to work their way into the Consumer Price Index. 

Risks

Depending on the index, stocks have gained anywhere from 5% (utilities) to 30% (energy) this year. Not bad. What could cause the “Year 2 bumps” that history suggests? Given easy financial conditions, strong earnings and slowly healing supply chains (see inventories above!), we would suggest an outside event.

The Delta strain is making its way around the globe and across the U.S. Cases have jumped by noticeable percentages over the last several weeks. Yet hospitalizations have not dramatically increased, but from our conversations the medical community is getting prepared. “Like going to war again,” we heard. Delta apparently multiplies much faster than earlier variants and is more easily transmissible. Applying India’s case experience to the U.S. situation may suggest a peak in cases near Labor Day. 

A different kind of attack is coming from China. As part of Xi Jinping’s reform efforts, regulators have cracked down on tech companies such as Jack Ma’s Ant and the ridesharing app Didi. Last weekend regulators effectively shut down the private sector education industry. Think test prep firms like Kaplan in the U.S., that help students prepare for university exams. Investors in response began selling healthcare stocks last week in fear that they would be next. Also in regulators’ crosshairs is the real estate sector.

What is the common thread among these industries? Data on Chinese consumers for sure, and that is something China wants to keep in their borders. Many of these companies’ top 10 shareholders are in the West. Through “variable interest entities,” Chinese companies can raise money through stock offerings in Europe and the U.S. while claiming Chinese ownership at home. VIEs are like tracking shares or depository receipts except they contain control interests, not shares. By cracking down on VIE-sponsored industries, China can hit Western interests in the pocketbook under the guise of regulation. Since early July the Shanghai Composite index has dropped 6.3% as investors decide it is not worth the worry. China represents over 30% of the Emerging Markets index. Our indicators have kept us underweight in Emerging Markets for at least the last six months.

Wrap-Up

The S&P 500 and Dow Industrials July performance was right on their historical averages for the month. July is usually the best month of the third quarter; here’s to breaking that rule. August ranks 11th out of 12 in stock performance and, yes, September has the worst track record since 1987. Remember, those are averages and this exceptional recovery year may provide different results.

Certainly, the fundamental backdrop remains in place. Earnings estimates are being guided higher by managements, interest rates are low, and most economies are either near expansion or already fully recovered. Technically, the rally in early July had narrowed to just the mega-techs. Amazon’s and Facebook’s warnings of slower growth (expected after stay-at-home clicking) took tech lower last week. But smaller stocks finally outperformed over the last ten days, suggesting broader participation. More mid- and small-cap stocks participating—what technicians call increasing breadth—is just what this market needs. The percentage of stocks above their 10-week moving average peaked back in December and has drifted lower since. Combining retail cash on the sidelines with a lot of stocks below their highs means there is plenty of “fuel” available for a rally later in the year. 

This morning’s ISM Manufacturing Purchasing Managers Index is the first July data point for heavy industry. The PMI reading of 59.5 was the weakest in six months. Inventories and prices fell, and finding workers remains difficult. New orders, production and deliveries continued to increase, but at a slower rate. This is the expansion activity that we expected in the second half: growth continues to expand, but not at as rapid a rate as the first half of the year. 

There should be a similar picture of slower, but still very good, growth in Friday’s payroll report. Net new jobs should top 600,000 and the unemployment rate should notch lower to 5.7%. Note that July is a seasonal adjustment month for payrolls, so the estimates cover a wide range from 300,000 to 880,000. The rest of our indicators remain green, and any seasonal weakness in markets is a buying opportunity.

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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