Market Update | Push and Pull
We are focusing on the Delta variant versus the strong earnings and macro data.
Figure 1: Market Performance as of July 31, 2021
Push and Pull: Summary
- Growth is back, but for how long?: While earnings are shooting the lights out and growth stocks have outperformed, the overall market is tilting back toward a neutral/bearish sentiment and forward guidance is not as encouraging.
- The Delta variant is a stark reminder that the pandemic is not over: Until we have achieved global herd immunity, COVID-19 has still managed to find pockets of unvaccinated to allow for aggressive mutations.
- Follow the vaccinations: The money seems to be flowing across the pond as Europe catches up and surpasses the US in vaccination rates.
You can read the full Market Update below.
Market Review: Market See-Saw
Markets see-sawed in July as inflation concerns and the spread of the Delta variant worried investors, while earnings results painted a rosier picture.
At a glance, U.S. markets in July seemed to have continued the trend from the past months to touch new highs, however investor skittishness remained on full display as markets see-sawed from week-to-week, threatening to end the bull run at any moment. Inflation, which was the primary concern in the markets over the past quarter, took a backseat in July as the Delta variant of COVID-19 continued to spread at an alarming pace across the country, mainly targeting unvaccinated individuals. Weekly average of new cases increased by five times just in July. Further exacerbating sentiment, news filtered in that the Johnson & Johnson single shot vaccine may be less effective against the Delta variant. In addition, the labor market has not recovered at the pace expected by the Federal Reserve, and while officials have reiterated their stance on inflation remaining transitory, companies such as ConAgra, PepsiCo, and General Mills, which are directly involved in the purchases of raw goods, have raised the alarm on price surges. Towards the last two weeks of the month a slew of good earnings results posted by companies boosted markets, however those providing forward guidance painted a tepid picture for the second half of the year largely forecasting earnings growth to remain mostly flat.
In international markets, investor interest has grown for companies based within the eurozone, especially as the reopening-induced recovery trade starts to wind down in the U.S., and Europe begins to reopen with around 70% of the adult population receiving at least one dose of the COVID-19 vaccine. In addition, IHS Markit’s manufacturing PMI (purchasing manager’s index) tracking economic trends in the manufacturing sector, has continued to rise over the past three months providing support to the recovery trade storyline. Unlike their European counterparts, Japanese markets have not had a good month despite the commencement of the Summer Olympics, as stocks continue to remain pressured by mixed earnings results, the state emergency being extended in Tokyo, and other prefectures to contain the surging delta variant.
The MSCI Emerging Markets Index fell sharply in July as developing countries continue to lag their counterparts in vaccination rates and new variants continue to wreak further havoc on the population and economy. In addition, the high weighting of Chinese stocks in indexes tracking emerging markets has had a negative impact over the past month. As the Chinese government continues to crackdown on technology companies, with the latest target being the ride-hailing giant Didi Global Inc., that was placed under scrutiny by the government over cybersecurity concerns just days after its listing on the New York Stock Exchange. In addition, the Chinese government has also demanded that the $120 billion private-tutoring sector to turn non-profit, resulting in stocks such as TAL Education Group plummeting by 70.7% in a single day.
Inflation concerns and a loose monetary policy centered around a long-term average inflation rate of 2% rather than a fixed threshold of 2% has continued to plague bond investors over the past three months. Weekly jobless claims have continued to stagnate between 360,000 – 400,000 and the labor markets seem to have hit a wall in recovery after an accelerating start, causing investors to question the Federal Reserve’s dovish stance. Between July 1st and July 19th, ten-year yields dropped by 29 bps to a low of 1.19%, a number not seen since February, as investor anxiousness over the potential growth impact of the Delta variant rushed into treasuries. While the bond market clawed back some gains in yields as positive earnings results caused some investors to jump back on the equity bandwagon, slowing economic growth data out of China reinvigorated the worry that the U.S. recovery could easily turn into the kind of stagnation currently occurring in China.
Crude oil prices dropped as low as 9.6% before recovering this past month as the OPEC+ reached an agreement to boost supply, and gold prices surged to a high of $1829 over inflationary concerns. An uneven global economic recovery coupled with wild weather fluctuations throughout the world has thrown the demand-supply balance into disarray. Prices of wheat, coffee, oats, and tea increased by an average of 15% over the past month as crop outlooks deteriorated in response to worsening weather conditions. In the cryptocurrency universe, stablecoins have become the latest instruments to be targeted by financial regulators especially as they mimic the current monetary system but exist out of the purview of the central banks. In addition, they also pose a monetary risk in the sense that pegging the value of the stablecoin to a fiat currency such as the U.S dollar allows for double lending on the same asset.
Going Forward: Push and Pull
Expectations matter. When expectations were dismal, any positive news seemed like a miracle. But now that expectations are high, the hurdle for a positive surprise is now difficult to achieve. For the first time in a year the Citibank Economic Surprises Index for the U.S. turned negative while we had our first broad survey downward revision for U.S. growth, according to the Bloomberg survey of economists. Further supporting this state of apprehension, U.S. yield curves bear-flattened with the long end falling as concerns around inflation went right out the window and concerns about the Delta variant drove the ten-year to 1.22%. Meanwhile, we have hit a peak for earnings growth, economic growth expectations, and labor market recovery in the U.S. So, is the party over?
The Continuing COVID Saga
As the vaccination push brought a dramatic drop in new caseloads, hospitalization rates, and death rates, it seemed that life in the United States might get back to normal. Businesses reopened, mask mandates were dropped and the country breathed a collective sigh of relief. This was quickly followed by a collective sigh of exasperation as the Delta variant emerged in unvaccinated pockets around the world spread into our own backyard among unvaccinated individuals. The new Delta variant, considered dramatically more transmissible by as much as 40-60% as the original Wuhan strain with viral loads as much as 1,000 times higher, has swept the globe. This was then followed by a gasp of concern as a small number of breakthrough infections hit vaccinated individual and talk of booster shots began to circulate. And, just like that, mask mandates were re-imposed and a general air of concern now permeates consumption decisions. As the summer re-opening boom begins to stall in the U.S., Europe has hit a gallop in terms of both vaccination rates and vaccination passes to support the reopening even in the midst of the Delta variant and other variants of concern. In China, the reopening has now evolved to stagnation while Japan, who should have been experiencing the fruits of the Olympics, are instead mired in a state of emergency. Though European earnings are largely peaking this quarter as well, pricing for European equities is significantly more attractive, having fallen below long-term averages. With markets shifting to more stable or less expensive assets, Europe could benefit.
In the U.S., the big offset to the recent market wobbles is the Infrastructure Investment and Jobs Act, a $1 trillion infrastructure bill for roads and bridges, broadband internet, public transit, and electric utilities expected to generate two million jobs per year over the next decade. This is expected to be followed by a companion $3.5 trillion spending bill that Democrats hope to pass through budget reconciliation that will include spending earmarked for climate change, childcare, housing, job training and education. Given the current state of the US government balance sheet it is easy to focus on the cost side of this equation, yet multiple studies suggest that positive impacts of infrastructure investment have large multiplier effects beyond the jobs created that would offset the impacts of deficit financing. However, offsetting is not surpassing, which is to say that while it seems like a positive thing to do, the passage of the infrastructure bill will be unlikely to significantly change the already positive outlook priced into U.S. equities. But not all equity analysts are good at math. So, it still could.
Emerging Markets Vulnerability
What is very clear is that many emerging market countries remain significantly vulnerable to COVID and companies that have outsourced significant portions of their supply chains to these countries in return for lower labor costs have discovered the price of dependability and stability. As commodity prices reflect the most basic shortages of labor, prices of intermediate goods are also creating inflation in the U.S. that could become permanent by virtue of onshoring. The great reversal in manufacturing may well be a boon to U.S. workers, cities, and states, it will also represent a jump in costs that will not be transitory, as the Fed suggests. The only scenario where the costs remain low is if onshoring occurs through automation, in which case expect a rise of the robot tax discussion. Either way, we see pressure on margins coming down the pike.
We remain neutral in U.S. equities on size and style. We also remain underweight Emerging Markets relative to US 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