Stretched? — Week of April 12, 2021

^{As of market close April 9, 2021. Returns in percent.}

Stretched?

Another week in a cyclical Bull, another series of records. Both the S&P 500 and Dow Industrials set multiple new records last week. The big S&P index set records five out of the last six trading days and the Dow three out of six. The tech-led NASDAQ calculated its index into first place for the month, rallying almost 5%. U.S. small cap and emerging markets, first-quarter stars, are bringing up the rear as we head into earnings season. 

What are the drivers now? Interest rates drifted a tenth of a percent lower, thanks to traders’ view on Fed hikes and concerns about slower growth in Europe. Calming rate markets helped tech shares whose cash flows are discounted by long Treasury yields. Short-term interest rate traders backed off a few weeks on their opinion of rate increases. The Fed has repeated to all who will listen that short-term rate increases will not happen until 2023 at the earliest. Traders, on the other hand, believe the Fed is always late and behind inflation expectations. Eurodollar futures suggest the first rate move by the Fed will be next summer. At one point that belief had moved briefly into the April–May 2022 time frame. 

Markets climb a wall of worry; we will get to those shortly. Checking the market’s heartbeat and pressure we find the technicals in good, if slightly stretched, shape. The percentage of stocks trading above their 200- and 50-day moving averages is near 90% of the index. Both are a sign of broad strength over the coming weeks. Over the last few days, however, the advance/decline line has stopped rising, and the ratio of winners to losers is barely positive. These are signs that the 5% run by the S&P may be due for a pause. Markets routinely get stretched up and down too far from their recent price action and need to consolidate to catch their breath. We may be entering another consolidation period during earnings.

It’s here

Last Friday’s Producer Price Index report put the “inflation when” argument to rest. We have been talking about coming inflation in consumer prices for months. On the wholesale and manufacturing side, it’s here. PPI popped 1% in March, the second-biggest jump since 2009. Year-over-year PPI rose 4.2%. About 60% of the rise was energy (fuel) costs. 

OPEC+ is a believer in demand recovery and higher prices. Members just raised prices for delivery to Asia and are scaling up production over the next several months. Leaving out energy and food, the “core” PPI rose 0.7% in one month, also the second-largest rise on record. 

The jump is almost entirely due to supply chain problems over the last year. Manufacturers shuttered plants during lockdowns, orders piled up, and now they are having trouble attracting workers. A portion of price increases are due to trade negotiations and unresolved tariff conflicts. For example, Canadian lumber tariffs have contributed to higher housing costs. The PPI for Final Demand Personal Consumption index is strongly correlated to the Consumer Price Index – where producers can pass along costs to consumers, they will. That index fell to -1.1% a year ago and posted a gain of 3.8% in March. The 2.6% CPI forecast for later this year may rise.

What’s missing…

Wage increases are the one driver missing from the inflation picture. The Job Openings data from the Bureau of Labor Statistics jumped for the third straight month in February. The 7.37 million job openings are the highest in two years. JOLTS data had spent the fall and winter hovering in the 6.5 million range. The job market train has quite a way to go to return to full employment, but increasing job openings is rolling on the right track. We note that surveys of job leavers returned to pre-pandemic levels – these surveys measure the comfort workers have in leaving a job because they are confident they can quickly land another. Demand for workers will only increase over the next several months as restrictions are lifted. 

The improving employment picture gives us pause. On one hand, employers are beginning to offer bonuses and perks to get new employees. On the other hand, we see that in the three rounds of stimulus, less than 30% of each payment was spent. According to the Federal Reserve Bank of New York, roughly a third went to pay down debt and the rest was saved. We would guess some of the savings will be used to pay rent and mortgages when the moratoriums expire. How much will eventually be spent? If federal and state governments issue more debt to pay workers not to work, how do the jobs get filled? A safe assumption is that wages have to rise – the black canyon of economists’ inflation nightmares.

Walls of worry

Factories are running near capacity; workers are hard to find, and orders for everything are rising. We hope you do not need a dishwasher or refrigerator. If you cannot find what you like on the floor, be prepared to wait months. These are good problems to have – the kind that could generate a 7% growth in GDP this year. 

Earnings season starts this week for the first quarter. We are hopeful that these reports will be the last reflecting ugly weather and lockdowns in their results. Year-over-year comparisons will be very easy for the first three quarters of this year compared with 2020. FactSet reports first quarter expected earnings growth of 24.5% from the first quarter last year. Twenty-three S&P 500 members report this week, led by J.P. Morgan, Wells Fargo and Goldman Sachs on Wednesday. 

Lots of liquidity from the Fed, along with an improving economy and earnings. What’s not to like? Geopolitical events generally have limited or short-term effects on markets. Indeed, they can be buying opportunities. We would note three items to keep on your radar. First is the Russian military buildup along the Ukraine border. The U.S. is responding to calls for help by airlifting military support items, including Humvees. The U.S. Navy is also sending two ships into the area. 

China is increasing its harassment of Taiwan. The U.S. high command cites China and specifically the threat of invasion of Taiwan as a very high concern. The takeover by China of the Taiwan Strait between the two countries would not only endanger Taiwan’s trade but also threaten shipping and trade from Japan. 

Last, increasing cases of the new British virus strain are forcing countries to increase or lengthen lockdowns and travel restrictions. Poland, India and France are logging their highest number of cases yet. None of these necessarily creates a market correction individually and thus far have not impacted our economic indicators. 

Wrap-up

Bull markets and record highs create frothy sentiment and stretched prices. We take them in stride as part of the back-and-forth flow of the markets. Strengthening economy, easy monetary conditions and low interest rates will keep stocks in the Bull cycle this year. 

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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