Tiny Tantrum — Week of August 23, 2021

As of market close August 20, 2021. Returns in percent.

Tiny Tantrum

August consolidation week? We wonder if the usual summer weakness is already behind us. Last week’s throwbacks cut August’s gains in half. Some of the decline was due to retailers' outlooks and earnings forecasts. But a good portion of stock selling came after the Fed’s June meeting minutes were released. The minutes did show that the Open Market Committee is discussing reductions to its bond buying program. Interest rates spiked and stocks sank 5% in 2013 when then-Chair Bernanke surprised traders by announcing that, in the future, the Fed would reduce its bond purchases. More on that in a moment. This morning’s announcement from the FDA of full approval of Pfizer and BioNTech’s Covid vaccine built on Friday’s up move and has decidedly improved sentiment. 

3 Peaks

“Peak is Past” was our July mantra. Rebounds in the economy, earnings and D.C. stimulus have accelerated the shutdown recovery. Each of those forces have peaked and rolled over. Earnings growth leads to economic growth and most of the tea leaves suggest both are downshifting from incredible to strong levels over the next several quarters. We would like to label earnings and economic growth “steady and strong.” 

The “steady” part of growth in the coming years will be influenced by D.C. policy and the Fed. The long-awaited infrastructure spending bill will be debated in Congress in the fall. $1.5 trillion spread over ten years is certainly a boost, and roads and bridges need help. We hasten to point out that before concrete hits dirt there is a lot of regulatory back and forth and in some cases lawsuits. Despite good intentions, much of the infrastructure spending will likely happen in the second five years. 

Powell Positioning

This morning’s rally after vaccine approval is a nice way to start the week. We do not expect much activity until Friday morning. Fed Chair Powell will speak at the annual Jackson Hole Symposium at 9 a.m. Central Time. The consensus is that Powell will address the issue of “tapering;” the reduction in the Fed’s bond buying program. 

Recall that when the shutdowns began the Fed began buying $120 billion per month in Treasury and mortgage bonds. Once the recovery took hold speculation began as to when the Fed would slow or even reverse its purchases. Several Fed regional bank presidents have put forth differing ideas on timing and amounts in recent speeches. The rise in inflation and strength of the recovery has the FOMC’s attention. Vice Chair Clarida recently expressed concern over the level of inflation and when he would favor raising interest rates. 

A quick look since the 2009 recession shows a strong correlation between Fed bond buying and stock performance. Since then, the major indices have risen almost step for step with bond purchases. When the Fed is buying, traders believe ample liquidity is available to support markets. The Fed has been involved in the bond markets in some manner, either in supporting money markets or buying long-term bonds, almost non-stop since 2009. Scaling down bond purchases would signal an “all clear” to markets. We are of the mind that Jackson Hole will serve as a starting point for tapering discussions and reductions in buying would most likely start at the beginning of 2022. 

Waves

The three peaks pushed the recovery wave to crest higher than we anticipated. We are mindful that the once a wave crests it drops and recedes. The delta variant spread is causing some forecasters to lower third and fourth quarter growth. We are not in that camp. We do expect slower growth in the coming months but do not believe a recession is imminent. 

Supply chains and worker shortages unfortunately are going to go on longer than anticipated. A number of the supply issues we have discussed with clients involve delta on one or both ends of the chain. Worker shortage issues have focused on child-care and fear of the virus. We would add the specter of Amazon looming over a region. How do small businesses compete when entire groups of $17 an hour workers move at once to a $20 per hour Amazon warehouse? At best, they accept lower gross margins and try to hire replacements at the higher wages. Result: wage inflation and slower employment growth. Slower employment growth would keep short-term rates lower for longer because the Fed now waits for “outcomes” to change, not “outlooks.”

Wrap-Up

Last week marked at least the sixth dip below the 21-day moving average for the S&P 500 and Dow Industrials. The tiny 1% tantrum over the Fed minutes may turn out to be just another (missed) buying opportunity. Today’s vaccine approval put the spurs to mega-tech and the S&P 500, with both hitting records intra-day. Much of the mid- and small-cap universe, however, remains stuck in neutral, range-bound since April. Rotation away from cyclical recovery, where small cap and value do well, toward growth may continue until clarity on the virus arrives. 

July’s existing and new home sales should show relatively flat growth from June. Markit’s monthly Purchasing Manager Indices for manufacturing and services both show drops from prior months. The readings are consistent with strong growth and activity slowing slightly due to shipping and virus issues. Overall markets are trying to figure out the path for inflation, wages and most important, employment. Our economic dashboard is still bright green. We remain fully invested and are looking for a break in the delta case data. 
 

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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