One down — Week of April 5, 2021

As of market close April 23, 2021. Returns in percent.

One down

Markets turned in their first quarter homework on Thursday, and we are pleased with their grades. In the stock size race, mid-caps barely beat their small company cousins, rising 13.1% vs. 12.4%. Mega Cap Dow Industrials and S&P 500 posted solid 7.7% and 5.7% returns, respectively. The Dow Transports hauled away first prize for the quarter, riding the recovery wave of 17% returns. Broad economic growth bodes well for industrial and financial earnings, and investors pushed value style stocks ahead of the celebrity growth stocks for the first time in recent memory. Large company value beat growth 10 to 1: 10.8% return for value to the tech-heavy growth group’s 0.8%.

Overseas performance cooled off thanks to local currencies. The U.S. dollar strengthened through March, but remember the dollar index value depends on the other currencies in the basket. The first quarter saw the Euro and other currencies weakening more than the dollar gaining strength. Changes in levels between currencies, coupled with increasing U.S. interest rates, means funds flowing away from emerging markets to the U.S. Emerging and developed markets returned between 3.3% and 4.5%, depending on the locale. 

Over the last six weeks, the S&P 500 made a run at 3,990 and finally broke through last Friday. First-of-the-month pension flows into stocks always helps. Usually breakouts are short-lived; a throwback below 4,000 should not be a surprise and would not mean any change in trend. Over the same period the index has repeatedly found support at its 50-day moving average and moved higher. The tech-heavy NASDAQ is the only U.S. index not in rally mode; its sideways consolidation is not cause for concern. Emerging markets are feeling the effects of renewed lockdowns by their Euro trading partners and weakening currencies. We would not be surprised if our indicators moved toward underweight in the coming months.

History class

“A fine start to the year, so what have you done for me lately?” ask traders. Thanks to Mr. Twain, we know that history does rhyme. Our trusty Stock Trader’s Almanac tells us that April is #1 since 1950 in returns for the Dow Industrials and S&P 500. Returns have averaged 2% and 1.5%, respectively. The last fifteen Aprils have been positive for the Industrials. More, please. Prior to the 1990s, the April pattern posted strong returns into earnings and then tapered a bit after tax season. That pattern is not as prevalent recently, and with the IRS moving some filing dates back this year, we wonder if this April will create any pattern at all. 

We are reasonably confident that first-quarter earnings will be good news. FactSet reports that over the last several months the median S&P 500 earnings estimate has risen 6%. Usually over the course of a quarter analysts decrease estimates. Over the last 40 quarters they have dropped earnings estimates by an average of 4.2%, according to FactSet. Earnings season kicks off with the usual big bank lineup of J.P. Morgan, Wells and Goldman Sachs on the 14th.

Five or twenty-five 

Last Wednesday President Biden unveiled his second legislative initiative. As promised, this package would have infrastructure and construction spending. The $2.3 trillion package would be spent over eight years and partially paid for by raising the corporate income tax rate from the Trump-era 21% to 28%, and increasing its enforcement. Thursday’s print edition of the Wall Street Journal had an excellent graphic breaking down the package’s spending. Only $115 billion, or 5%, was allocated to bridges and highways. Taking the roads and bridges money and adding airports, public transit and electric vehicles, the total comes to 25%. Infrastructure is one area that both parties agree on. Government and the private sector also agree that our roads and highways need upgrades and overhauls. 

Every four years, the American Society of Civil Engineers issues a Report Card on America’s infrastructure. They assign letter grades for physical condition and needed investments for improvement. Most of the nation’s roads get a C- at best. Dams and bridges are the same or worse. Overall, Texas scores a C; our roads, a D+. Ouch. The Association of State Dam Safety Officials estimate that rehab of our 7,200 dams in Texas will run at around $5 billion. The size of the infrastructure portion left Wall Street underwhelmed, and the Dow Transports sold off on the news. The ambitious and broad sweep of the proposed legislation makes us think June passage is reasonable.

Second wave

The Bureau of Labor Statistics March employment report blew away estimates. An estimated 916,000 net new jobs were counted in the survey period, well above estimates of around 650,000. Employment was higher in every category. Thanks to easing lockdown restrictions and vaccinations, food service and bars jumped by 176,000. The resumption of in-person teaching at many school districts boosted government and private education by 190,000. The unemployment rate dipped to 6%, only 2.5% above the 3.5% pre-pandemic low. 

Year over year the country has recovered over half of its initial job losses. Most of that recovery occurred last summer with the nearly 11 million jobs gained in the first wave. According to the official tally, we are 8.4 million jobs below the employment peak of February 2020. Job gains over the last three months: +233,000, 468,000 and 916,000. These levels should be the “new normal” for the next several months as the recovery gathers momentum. They represent the second wave of job recoveries that should push the unemployment rate to 5% by the third quarter. Will we return to pre-pandemic employment levels? We certainly think so. Stimuli from the Fed and Congress are a tailwind; but finding entrepreneurs willing to risk new restaurants is a headwind. The 8.4 million number is also up for debate. There is a line of thinking that, over the last year, teacher retirements and other early-out packages may have reduced the number of boomer-age workers by a permanent 2 million or more. If so, that is good news for recent college graduates. 

Increasing help wanted signs and stimulus checks contributed to the largest jump in the University of Michigan’s Consumer Confidence survey since May 2013. The 84.9 reading in March was a substantial jump from the blizzard-buried 76.8 of February. Expectations also jumped to 79.7 from 70.7, and current conditions rose to 93 from February’s 86.2. Both series point toward improving consumer spending. The University of Michigan survey questions on inflation have a remarkably accurate track record. Year-ahead inflation expectations for inflation were 3.1%, and for five years out, 2.8%. These consumer feelings about inflation mirror the markets. One-year inflation swaps are trading around 2.7%, and TIPS breakevens at 5 years are projecting 2.6%. 

Wrap-up

Stocks usually start the Monday after Easter in a down mood. We are looking forward to a better day after Friday’s winning jobs number. Interest rates have paused their rise momentarily. Rates are caught between an improving economy demanding more credit and increasing Treasury bond supply on one side, and Fed buying and aging demographics on the other. We believe higher rates are ahead, but not the 6% and 8% levels of the 1980s and 1990s. 

Stocks and commodities remain in uptrends; valuation and sentiment are a bit full at the moment. Valuations can be resolved to more reasonable levels by strong earnings. Sentiment usually swings too far one direction and then too far the other. Earnings season is also a way to calm sentiment. 

Is there a color more “red” than just red? Our economic indicators this time a year ago were the reddest possible color. Now they are green shoots with firm roots. The economy is in recovery mode, and vaccines are winning the Recovery Race over the virus. Patience is the order of the day.

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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