Shuffling Along — Week of September 13, 2021

As of market close September 10, 2021. Returns in percent.

Shuffling Along

What did we say about corrections in the fall? Not that last week is anywhere near a correction. Declines of 1% to 3% across sectors and indices are hardly a trend change. It marked the first week since June where every day was lower for the S&P 500 and Dow Industrials. The big indices have had over 1% down weeks throughout the summer, each centered around options expiration. This coming Friday is triple witching day, when stock options, stock index futures and stock index options expire simultaneously. Since it is the end of the quarter, we would expect more volatility than usual. 

Mega cap growth and the S&P 500 sit right below their all-time highs. Both the S&P and NASDAQ have split two weeks up and two weeks down over the last month. Our mid- and small-cap friends have not fared quite as well, shuffling to negative returns in three of the last four weeks. Both sit right on top of their 21-week moving averages. 

Thursday the 2nd marked the local peak for the headline stock averages and their internals. Since then, the advance decline line, net new highs and percentages of stocks above their moving averages have all rolled over. Short-term sentiment has turned mixed: retail investors are becoming more pessimistic (bullish), while traders have stayed excessively optimistic (bearish signal) for most of this year. We are always looking for divergences between indicators and markets — they can mark turning points. Optimism has been rewarded this year with higher earnings and prices. To date, 2021 reminds one of 2017: relatively low volatility, very small corrections, if any, and earnings surprises. Market internals are telling us that the remainder of this year will be a repeat of 2020: the delta variant will throttle the economy and sentiment up and down. 

Stock’s small slide last week was not enough to rouse bond markets from their slow shuffle higher. In low inflation periods, bond prices tend to rise when stock prices fall, as traders use bonds for a risk-off haven. During periods of rising inflation, bond prices tend to go their own way. Last week was a good example. On August 4th the 10-year Treasury dipped briefly to 1.12%, making a chart double bottom with the same level on July 20th. Since then, rates have climbed steadily higher. This morning the 10-year sits at 1.32%. Thirty-year rates have barely budged over the same period, rising only one-tenth of a percent. Some of the pressure on rates comes from record issuance of debt by corporations. When companies issue new bonds, their underwriters usually sell Treasuries to hedge rate risk.

Slightly higher rates have not dented demand or supply for municipal debt. Possible tax increase discussions in D.C. always push demand for munis higher, and issuers are responding. Flush with above budget tax receipts and capital gain inflows, credit quality continues to improve from a year ago. This week over $9 billion in new issues will come to market, well above this year’s weekly average of $6.4 billion. The one large Texas deal on this week’s docket is Austin’s $163 million Public Improvement issue.  

Higher Still 

We think a lot of the inflationary price pressures in both supply and demand come back to one factor: labor. Virus shutdowns at Asian factories and ports crimp shipments. Cargo vessels and containers are piled up in the wrong ports due to labor shortages. After waiting days to get into harbor, containers have nowhere to go because of a shortage of truckers and rail employees. Just in time for the holiday stocking season, retailers are reporting inventory shortages because if stuff does get to the loading dock, there are not enough workers to stock shelves. 

If we doubted our thesis, we got a good jolt last week. The BLS Job Openings survey for July stomped higher to a new record last week. The JOLTs report just missed 11 million, coming in at 10.93 million openings. Contrast record hiring demand with the official tally of unemployed of 8.3 million people. The pool is smaller after adjusting for childcare, retirements and lack of skills. A reasonable estimate is 2:1, or two openings for six million unemployed. Meanwhile, we continue to hear of clients raising starting wages, an excellent example of “wage push” inflation.

Take note of last week’s initial unemployment claims hitting a post-pandemic low of 310,000. If this series continues to decline over the next few weeks, then we can surmise that the end of the $300 per week unemployment stimulus motivated some folks to return to work. Ergo, the JOLTs report in December should show a meaningful drop and nonfarm payrolls should average at least 500,000 in October and November. 

We think pent-up consumer demand from the shutdowns has largely been satisfied. However, companies still need to restock inventories and fill orders. Materials and wages factor into the Producer Price Index, the inflation gauge for industry. PPI should have the full attention of the Fed. Year-over-year gains of 8.3% pushed the index to highest annual gain in 11 years. Excluding food and gasoline, the “core” PPI rose an impressive 6.3%. 

Digging into the details, some price indices appear to be leveling off. Breaking the uptrend is the first step to lower prices. We do believe that over the next year inflation will moderate to lower levels. It will not return to the sub-2% zone. Note that the PPI for final demand personal consumption hit a new record at 7.4% y-o-y. This series correlates very well with CPI, suggesting that producer price increases will find their way into consumer prices in the coming months. For much of the last two decades consumers enjoyed either lower prices, think Walmart and tech-improved supply chains, or disinflation in the form of “Now 10% more Tide!” Those days are over for now. 

Interest rates and the U.S. dollar are both slowly trending higher. The 10-year Treasury yield twice hit 1.12% earlier this year. Now, even as growth is slowing thanks to the delta variant, traders are pushing yields higher in preparation for Fed tapering. At 1.34%, the 10-year yield remains extraordinarily low. If traders can push through chart resistance at the 1.46% level, there is not much stopping rates from rising back to the 1.75% area of last March. Thinking of refinancing? 

Wrap Up

August monthly economic data starts to hit the tape this week. CPI, Industrial production and Manufacturing output should be near peaks. CPI will likely be 5.5% y-o-y and remain in the 4% area through the rest of the year. Manufacturing activity appears to be shifting from pandemic catch-up to more orderly inventory rebuilding. On the downside, retail sales and jobless claims should continue to drift lower. The headline retail sales number will be dragged down by lower auto sales (reflecting low supplies); most categories continue to do well. 

August’s job gains of 243,000 signaled deceleration across a wide swath of the economy. We expect numbers over the next couple of months to pull our GDP estimate for the third quarter lower by a full percentage point, from 6.5% to 5.5%. We hear of even lower estimates, but we think the delta recovery may start sooner than media wisdom expects. 

Our dashboard is shifting from recovery small and value-based sectors to larger cap and expansion sectors. All remain at least neutral to bright green and keep us fully invested. 
 

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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