Treats — Week of October 25, 2021

As of market close October 22, 2021. Returns in percent.

Treats

Is this an early Christmas gift from the markets?  Another week of new all-time highs certainly puts one in the holiday spirit. Every U.S. sector finished in the green, along with most foreign bourses. The only red on our screens was Chinese energy and coal miners, thanks to the Communist Party’s diktat that they should cut prices. 

The big four U.S. indices all rose more than 1%. The Dow Industrials, S&P 500 and S&P 400 Mid Cap all set new records. Dow Transports and Utilities are finally turning higher but still below their recent peaks. The tech-laden NASDAQ likewise sits just 1% below its recent high, a nice jump from the 7% drop of early October. 

Certainly the low one-way market volatility and higher interest rates should give us pause. Generally, when volatility, as measured by front-month S&P 500 futures, gets this low (VIX at 16), markets can turn choppy then move higher after several months. Perhaps the fall “choppy” season was contained in September. Interest rates hit their highest levels since April and Fed Funds futures are pricing in a better than 50% of a hike in short rates in mid-June next year. But markets seem to be taking higher rates in stride. We would ascribe their calm to good market messaging by Chairman Powell, and just as importantly, the fact that tapering of bond purchases does not mean the Fed is shrinking its balance sheet. There is a strong correlation between the Fed’s balance sheet and the level of the S&P 500. 

Delta Dip

July and August data showed a “delta dip” as cases and restrictions climbed. U.S. delta counts peaked in the U.S. on August 27th. Since then, data ranging from restaurant visits to factory output indicates acceleration. 

Each of the four previous corona-based epidemics over the last 100 years has had multiple variants run through populations. The latest variant to raise alarms is circulating in the U.K., pushing case counts back to their July delta high. Early research suggests that this variant replicates faster than delta, making it more transmissible. 

Mass Transit

One of the urban trend changes wrought by the pandemic is the decimation of mass transit. Nobody wanted anybody breathing on them. Used car prices went nuts as folks scrambled for their personal commute space during reopening. New car prices have held steady and climbed at the dealer thanks to chip shortages. Now another shortage looms on the horizon for the auto industry: aluminum. 

China is running the gauntlet of power, pandemic and policy. The new policy is to cut pollution for the Olympic games. That involves cutting back factory output. Another policy calls for buying less power plant coal from Australia over pandemic squabbles. Result: China ordered 35 of 50 manganese smelters to shut down. This clears the air and releases some electrical plant capacity. But manganese is a key component of aluminum alloys used in cars. A group of industry associations in Europe said that the drop in Chinese exports of manganese means the auto industry there will run out of the metal in a few weeks. Auto plants will have to stop production as a result. Back to mass transit down the road?

Mixed Picture

The third quarter earnings season is yet young, with only 23% of the S&P 500 reporting through Friday. The early returns are promising for Bulls. According to FactSet, 84% have reported earnings beat and 75% a revenue beat. Eight sectors are reporting higher revenue and earnings estimates than predicted back at the end of September. Year-over-year third quarter earnings are running at a 32% increase, well above the low 20% increase we discussed earlier in the summer. If that 32% increase holds for the balance of earnings season, it will be the third-highest growth rate since the third quarter of 2010. The sector leaders so far are energy (crude, up 82% over last year), industrials and financials. 

AT&T was typical of last week’s reporters, announcing 9% earnings beat and adding 1.2 million wireless subscribers, nearly double forecasts. American and Southwest announced losses that were slightly less than expected thanks to labor and reopening difficulties. Traders are reacting very positively to the beats — the average stock is trading 1.6% higher after a beat last week. This suggests to us those  traders were likely positioned for delta-pressured “ok” news instead of “decent-to-good” news from company management. 

Week One of earnings season is for the big banks, week two is old timers, and this is FAAMG week. That is short for Facebook, Apple, Amazon, Microsoft and Alphabet (Google’s parent). Today Otis Elevator should push the “up” button and Facebook may start its makeover with a new corporate name. Tuesday, we are very interested to hear if Sherwin-Williams is having more difficulty sourcing chemicals and how UPS is going to deal with holiday shipping. Hershey, Caterpillar and Phillips 66 round out the week. 

On the global front, consumer brand giant Unilever (Lipton, Dove, Vaseline) reported sales growth of 2.5% year-over-year, just below estimates, but realized 4% higher prices. In other words, unit sales are down as consumers react to higher prices. Volvo reported a huge 75% YoY jump in North American truck orders but noted that Chinese heavy equipment orders had dropped “sharply after several years of high demand.” We wonder if the drop in orders is related to financial problems of the big real estate firms like Evergrande, Fantasia and Modern Land. Lower heavy equipment orders fit with a drop in Japanese machine tool orders, a proxy for global industrial spending.

Wrap-Up

Commodities still grab the inflation headlines. Most prices have peaked and rolled over but remain elevated year-over-year. We are not optimistic about the manganese/aluminum situation. The post-Industrial Revolution world had its first “policy recession” in 2020 from the pandemic shutdowns. A second policy recession driven by developed countries' desire to stop burning coal without adequate power backup would be hard to imagine. Rolling power blackouts in the U.K., Europe and China make us wonder. Blackouts mean cold citizens and lost productivity. 

Setting aside that small probability, we still have a near-zero reading on our recession monitors. Indeed, we are looking for an acceleration of the economy in the fourth quarter, as delta cases continue their seven-week slide. October is delivering some nice treats.

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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