Good start — Week of April 19, 2021

As of market close April 16, 2021. Returns in percent.

Good start

Another week of records for the Bull and more to come. The Dow Industrials and S&P 500 both notched more records last week. Both have risen for four weeks and the NASDAQ for three. We may think markets are stretched, but neither Bulls nor Bears care about investor feelings. Every sector but energy is overbought at the moment and should be due for a pause. Earnings, calm interest rates and vaccinations appear to work wonders.

Earnings season got off to a fine start last week with each of the big banks meeting or beating estimates. J.P. Morgan, Citi and Goldman Sachs all profited from big gains in trading but saw little or no growth in loan demand. Last year companies rushed to tap bank lines and hoard cash. We expect a number of companies will use that cash for stock buybacks and possibly merger activity in the coming weeks. As a group, the first week’s reports beat analysts’ estimates by 38%. FactSet says the average beat over the last 15 years is 4.7%, so that is good news.

Lagging

Emerging markets – think China, India, Brazil – as a group performed well after the second virus wave in 2020. Their manufacturing orientation lent their economies to an earlier reopening than service-oriented economies like ours did. New virus strains and uneven vaccine rollouts have hampered the group’s recovery this year. Massive stimuli here and in Europe have helped developed countries catch up and, at least in growth measures, pass their EM counterparts. 

The biggest risk to EM countries is the new virus strains and how they may react to vaccines. Most EM countries have had less than 10% of their adults receive at least one dose. Last week India passed the U.S. in case growth, and Brazil is gaining. Ukraine, Poland and Turkey are now seeing their highest daily case numbers since the pandemic began. Many of these countries are fighting food price inflation thanks to shipping and drought problems. This presents the odd possibility of a country faced with raising interest rates to keep prices down, while struggling to keep the economy going. We hope that decision is not presented for some unlucky officials. India’s stock market began to drop just after cases began to rise in mid-March.

Rising tides

From an investment standpoint we do not believe the Recovery Race is won here at home. True, the third wave has crested, and daily counts are back to levels last seen in late October. The most recent daily peak was on April 9 at 85,670, according to the worldometers.info website. Vaccines have been winning and, happily, reopening is happening faster than we anticipated. The pandemic reminds us of the waves at the beach. In 2020 the pandemic shutdowns pulled the water out to sea, and we briefly sunk into soggy sand. Now the waves are crashing back in, and instead of sloshing around our ankles, the economic wave is splashing our knees and pushing us back. 

Rising economic activity caught shippers, manufacturers and refiners off guard. Shutdowns and less spending a year ago depressed prices of consumer goods. Now reopening tides have the opposite effect. Prices are showing year-over-year jumps partly because prices in March of 2020 were falling. Economists like to call this phenomenon “base effects,” but we just call it inflation. March’s Consumer Price Index rose 2.6% over year-ago levels, and April’s will likely be above 3%. 

Falling prices a year ago do not tell the whole story. Part of the increases are due to a 5% jump in energy prices over the last month and a surprising increase in shelter of 0.3%. Shelter was entirely due to a 3.8% annualized jump in “lodging away from home,” or hotels, for short. Folks are traveling again – have you tried to rent a car during the last couple of weeks? Regardless of the sector or reason, higher prices are a feature of recovery, and we should expect CPI numbers to stay north of 3% for several months. We do agree with the Fed that inflation during recovery is transitory. Post-recovery, when the economic tide settles down, we will examine whether the economy is starting another long-term inflation cycle.

Better reflation

March retail sales also rebounded higher than expected from February. Analysts factored in February’s storms and March stimulus checks but were still surprised by the second-largest jump ever month on month. May 2020’s first reopen sales jump of 18.3% is the largest on record. March’s 9.8% increase was four points above estimates. Some of the increases in sales are due to higher prices paid by consumers. Taking away higher gas prices, “core” retail sales were still better than expected. Autos (+15%!), bars and restaurants, and clothing were the leaders. Heath and convenience stores sales fell 2.5%. 

Over the last year, five of the 13 retail sales sectors are showing gains of at least 20%. Even more impressive, Bespoke Research reports that the level of retail sales are well above pre-pandemic levels. The surge in retail sales contributed 7.1% of the 8.3% (86%) GDP estimate in the New York Fed’s GDPNow model for the first quarter.

Respondents in the monthly University of Michigan Consumer Sentiment Survey were the most optimistic in a year. Unsurprisingly, vaccinations and stimulus checks boosted the current outlook. The expectations index was lower than expected because consumers are concerned about inflation over the next 12 months (+3.7%) and vaccine safety. We have commented before about the impressive correlation between the Michigan inflation numbers and actual inflation numbers down the road. Like the Fed, consumers do not see the coming inflation spike as permanent: their five-year inflation expectations are around 2.7%.

At the factory

Industrial production continues to improve and impress. March’s reading rose 1.4%, disappointing the consensus estimate of 2.6%. Why the miss? The Federal Reserve’s Industrial Production index consists of manufacturing and utilities output. March’s warm weather dropped utility output by 11%, which offset manufacturing gains of 2.5% and mining (mostly oil drilling) gains of 5.7%. Overall production is up 1% year over year for the first positive gains since August of 2019. 

Other excellent gauges of business and manufacturing activity are the Philadelphia Fed and New York Fed regional general business conditions indices. Both are rising to post-pandemic highs driven by gains in new orders and increasing raw material prices. Like the Beige Book report, companies reported lengthening supplier deliveries and difficulty in finding workers. 

Wrap-up

We are frustrated that the virus has not meekly retreated around the world. We thought our friends overseas had borne the brunt of the virus prior to the U.S., but they are now seeing their highest case counts. The Fed meets again this week, and we expect no meaningful changes in the bond-buying program or outlook. Chairman Powell’s press conference is on Wednesday. 

Vaccinations, reopening and recovery have lifted our confidence and flowed into a rising economic tide. The OECD’s U.S. Composite Leading Indicator rose last month for its 11th consecutive gain. At 100.2 it now shows above-trend growth for the first time since December 2018. That’s right, 2018. The index has a good track record of suggesting future growth ahead. 

We will withhold judgment on earnings season for a couple weeks until roughly half of the S&P 500 have reported. We are pleased that almost all our indicators are green, and none are flashing warning signs.

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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