MARKET UPDATE | Peak Markets | September 2021
We explore the challenges of market peaks and the psychology of downward revisions.
Figure 1: Market Performance as of August 31, 2021
Peak Markets: Summary
- Equity markets continue to climb the wall of worry: FOMO is keeping investors in growth stocks but the delta variant and the peaking of market expectations and the end of easy comps are creating market volatility making for challenging markets.
- Supply chain disruptions and labor market shortages continue to test market patience in the transitory inflation concept: ten-year bond yields are being driven primarily by delta variant risks sending them well above what the long end can eke out with rangebound breakeven inflation and minor downward revisions to very strong GDP growth expectations.
- International markets remain mixed with vaccination rates the most important metric: Europe’s 70%+ vaccination rate continues to shine through with GDP growth revisions and expectations still on the upswing.
You can read the full Market Update below.
Market Review: Interesting Times
Key influencing events over the course of August include the Senate’s passage of the infrastructure bill in the first week, the spread of the delta variant in the second week, the dramatic fall of the Afghan government to the Taliban following the departure of the U.S. military in the third week, and the Federal Reserve’s Jackson Hole Symposium in the final week.
U.S equities hit new record highs in August as loose monetary policy and record low interest rates have made investors loath to shift away from equities. President Biden’s $1.2 trillion infrastructure bill passed the Senate towards the end of the first week, boosting equities, particularly in the utilities sector. However, the increase in the delta variant caseload combined with lackluster progress on vaccinations ushered in a bout of volatility. Adding to the volatility, the fall of Afghanistan’s government and subsequent takeover by the Taliban led to a major selloff in broad equities and rotation towards the growth sectors of technology and communication services. Weekly jobless claims have fallen to the levels of 350K, and nonfarm payroll numbers continue to improve from month-to-month, however the recovery in employment seems to fall short of the Federal Reserve’s expectations. Minutes from the latest FOMC meeting and news from the Jackson Hole Symposium reverberates the same content: the Federal Reserve considers the current inflation numbers to be transitory and may start to taper on the monthly $120 billion bond purchases by the end of the current year, but a rate hike is not expected any time soon. Investors continue to remain concerned as Quarter-over-quarter GDP growth over the second quarter came in below expectations. Growth is primarily driven by government spending, investments, and post-vaccination consumption demand. But, net exports continue to fall as other countries lag in vaccinations. And, though, personal spending is reverting to normal and personal income is rising, inflation threatens to run hot and the biggest fear on investor minds is the Federal Reserve being unable to commandeer the mammoth vessel that is the U.S economy as we float further into unchartered waters.
In international markets, Europe continues to benefit from investor interest and rose for the seventh consecutive month, suffering a blip in the middle of the month when the U.S withdrew from Afghanistan and the Taliban toppled the previous government. While the spread of the delta variant continues to remain a concern, many governments plan on providing booster shots, buoying investor sentiment. While Europe has largely stemmed the rise in new cases by vaccinating roughly 70% of their population, Japan continues to be plagued by a slow vaccine rollout as well as vaccine recalls due to contamination, resulting in extended lockdowns and a slower than expected recovery.
Emerging market indexes continue to underperform their developed counterparts with China as the primary laggard. China was one of the first countries to emerge from lockdown. The government has taken advantage of the discrepancy in recovery timelines between nations to increase regulatory oversight in key sectors such as finance, technology and education, without causing a seismic rotation out of Chinese equity markets. Record low rates around the world, a surge of individual investors as well as thematic ETF’s and ballooning government balance sheets in the west have left investors stuck between a rock and a hard place, in search of yield and stability and keeping them invested in China.
The yield curve steepened in August, reacting to falling unemployment claims, and improving numbers of nonfarm payrolls. Breakeven inflation numbers have also been exhibiting low volatility, however there are lingering signs of investors losing confidence in the Federal Reserve. Future monetary policy appears dependent on yet another raising of the debt ceiling and Jerome Powell being reinstated as Fed Chairman; a more dovish Fed Chairperson could spook markets heavily. In addition, the notion of transitory inflation being pushed by Fed officials largely rests on dampening the disruptions to global supply chains due to mutating versions of the coronavirus and labor shortages. Should either of the two remain persistent in the foreseeable future, central banks will be forced to scale up the pace of tightening their monetary policies, resulting in investor attention shifting towards the underlying credit qualities of each security, and a repeat of the European debt crisis but on a much larger scale.
Oil prices have continued to remain stable over the past month as the OPEC+ continues to raise production levels slowly. There have been fluctuations in WTI crude oil prices owing to the extreme weather conditions as well as reported drop in inventory levels. Extreme weather conditions have also pushed up food prices globally as a supply shortage for commodities such as wheat has driven exporters to hold onto stock. Precious metals such as gold and silver, have been focused on employment data, surging in price at the slightest sign of growth slowdown, however they now also have to compete with cryptocurrencies which are fast carving a niche for themselves in investor portfolios as an inflation hedge.
Going Forward: Peak Markets
The greatest danger in any market is the point at which strong performance begins to underperform even stronger expectations. What tends to follow is a game of catch up with downward revisions and moderating and less and less positive earnings. And, though in the case of the U.S., we are talking about GDP moderating from 6.3% to 4.3%, still well above long term trend growth and earnings slowing from 92% Quarter-over-quarter comps to an average of 10% Quarter-over-quarter comps over the course of the next four quarters. These are strong numbers, but the psychology combined with the frothiness in valuations and the potential for tapering or a rate hike certainly make the markets less appealing than before. The big question in our minds concerns the level of employment and activity we can expect once we get back to “normal” whenever that is. Will personal incomes, consumption and business investment settle back into previously established trends or will they be faster or slower. What we know is that much has changed in the past year and a half and some of the changes will fundamentally change the outlook for certain companies, sectors, and market segments. The trick is to anticipate the winners and losers.
As the vaccination push brought a dramatic drop in new caseloads, hospitalization rates, and death rates, it seemed Many of the trends that were in place prior to the pandemic including the move into cloud computing and storage and business continuity were already in place prior to the pandemic and in many ways, facilitated the quick adoption of remote work by many companies. Those segments of the technology sector remain attractive even despite some pricy valuations as the movement continues to gain strength. However, this will also facilitate professional services under the Industrials umbrella which run the gamut from outsourced services to consulting services that can be more efficiently delivered through virtual means.
In the U.S., the big offset to the recent market wobbles is the Infrastructure Investment and Jobs Act, a $1 trillion In addition, Infrastructure spending remains a highly anticipated economic stimulus measure that will certainly benefit planes, trains and automobiles, but not necessarily electric automobiles, which didn’t get quite the allotment Democrats originally pushed for. However, there will be some significant investment into Amtrack and airport upgrades which will benefit industrials, materials and commodities fairly broadly. The investment of internet infrastructure into poorly serviced areas will be an enormous boon to internet providers and all of the communications services that rely on that ethernet highway. However, no one could agree on how to fund this massive spending with Democrats baulking at a gas tax and Republicans balking at a rise in corporate taxes. So, they are going after cryptocurrency gains instead, which could be a big loser in 2022 as the tax reality bites the average investor.
What is very clear is that many emerging market countries remain significantly vulnerable to COVID and companies Vaccine hesitancy in wealthy countries remains a greater impediment to ending the pandemic than the lack of vaccine availability in poor countries, though both present real problems. Europe is leading the charge at this point, having crossed the 70% threshold for vaccinated adults just ahead of the U.S. in late July. Because Europe had not experienced the run up in expectations, the upward revisions occurring now have a greater potential to be sustainable as the bloc reopens. However, the lack of vaccine availability in poorer countries remains a significant concern as supply chain disruptions are driving a massive re-shoring of manufacturing in wealthy countries like the U.S. and Europe. This could leave some Emerging Market countries far worse off after the pandemic subsides.
We remain neutral in U.S. equities on size and style. We also remain underweight Emerging Markets relative to U.S. and add an overweight to Europe relative to Japan.
Past performance is not an indication of future performance. The information provided in this newsletter is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any types of securities. There is a risk of loss from investments in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.
The information contained herein reflects Lido’s views as of the date of this newsletter. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Lido has obtained the information provided herein from various third-party sources believed to be reliable, but such information is not guaranteed. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Lido is not responsible for the consequences of any decisions or actions taken as a result of information provided in this newsletter and does not warrant or guarantee the accuracy or completeness of this information.
The MSCI All Country World Index is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 27 emerging markets. As of November 2020, it covers more than 3,000 constituents across 11 sectors and approximately 85% of the free float-adjusted market capitalization in each market. The index is built using MSCI’s Global Investable Market Index (GIMI) methodology, which is designed to take into account variations reflecting conditions across regions, market cap sizes, sectors, style segments and combinations. (Source: MSCI)
The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. (Source: Russell)
The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. (Source: Russell)
The Standard & Poor’s 500® is a market value weighted index that includes the 500 leading U.S. based companies and captures approximately 80% coverage of available market capitalization. (Source: S&P Global)
The Dow Jones Industrial Average™ was introduced in May 1896, is a price-weighted measure of 30 U.S. blue-chip companies. (Source: S&P Global)
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. (Source: Russell)
The MSCI All Country World Ex U.S. Index is market-capitalization-weighted index maintained by Morgan Stanley Capital International and designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The MSCI All Country World Index Ex-U.S. includes both developed and emerging markets. (Source: MSCI)
The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries. (Source: MSCI)
The MSCI Emerging Markets Index captures large and mid-cap representation across 27 Emerging Markets countries. With 1,397 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. (Source: MSCI)
The Barclays U.S. Universal Index is an unmanaged index comprising U.S. dollar-denominated, taxable bonds that are rated investment grade or below investment grade. (Source: Barclay’s)
The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). (Source: Barclay’s)
The BofA ML U.S. High Yield Master II Index tracks the performance of U.S. dollar denominated below investment grade rated corporate debt publicly issued in the U.S. domestic market. (Source: BofA Merrill Lynch)
The Bloomberg Commodity Index is a broadly diversified commodity price index distributed by Bloomberg Indexes. It tracks the price of furutes contracts on physical commodities on the commodity markets. (Source: Wikipedia)
The Alerian MLP Infrastructure Index is a composite of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index has 25 constituents that earn the majority of their cash flow from the transportation, storage, and processing of energy commodities. (Source: Alerian)
The S&P GSCI Gold Index, a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark tracking the COMEX gold future. The index is designed to be tradable, readily accessible to market participants, and cost efficient to implement. (Source: S&P Global)
The BofA ML 3-Month T-Bill Index is an unmanaged index that measures returns of the three-month Treasury Bills. It consists of a single issue purchased at the beginning of each month and held for a full month. (Source: Lido)
The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies falling within four principal strategies: equity hedge, event driven, macro/CTA, and relative value arbitrage. (Source: HFRX)
The Dow Jones Real Estate Index is designed to track the performance of real estate investment trusts (REIT) and other companies that invest directly or indirectly in real estate through development, management, or ownership, including property agencies. (Source: S&P Global)
LA21MUBG03 — March 2021 Market Update