@theMarket: Economy Grows Less Than Expected
The good news first. The economy grew by 6.5 percent in the second quarter, which was one of the best quarters in recent memory. The bad news: it was a big miss.
Economists were expecting an 8.4 percent rise, but the markets took it in stride. One explanation is that investors are well aware that the macroeconomic data is, at best, somewhat unreliable and prone to large revisions. It is not the government's fault. The pandemic and subsequent reopening of the economy has made gathering economic data difficult.
Another reason investors gave the miss a pass is that consumer spending, the biggest component of U.S. economic activity, exceeded expectations. A stronger than expected number supports the case that the economy is still in good shape. It was shrinking inventories, rather than a falloff in demand, that dented growth. Supply chain restraints and shortages were a substantial part of the drawdown in inventories.
The weaker GDP number is also one of those "bad news is good news" events, since it supports the Fed's argument that there is no need to tighten right now. This month's FOMC meeting, and Fed Chairman Jerome Powell's press conference, drove the point home that there would be no change in policy.
For the time being, Powell said, the Fed will be more focused on gaining jobs than in controlling a temporary spike in the inflation rate. Bond traders are guessing that at some point in the fall we can expect the central bank to begin tampering their bond purchases. Of course, the wild card will continue to be the spread of the Delta variant of the coronavirus.
On the political front, kudos are in order for those on both sides of the aisle. Senators from both parties finally arrived at a compromise on infrastructure spending. The 67-to-32 Senate vote, which included 17 Republicans in favor, cleared the way for passing the first infrastructure bill in years. President Biden deserves credit for his ability to lead (as well as to compromise). But investors should know that there is still a long way to go before this deal becomes law.
My own disappointment centers around the fact that this agreement only includes $550 billion in new federal spending spread over many years. It is not nearly enough, in my opinion, to repair and rebuild a nation's worth of roads, bridges, railroads, transit, water, and other necessary physical infrastructure programs.
For example, just repairing (or rebuilding) one century-old tunnel that connects New Jersey with Manhattan would cost $11.6 billion or more. How many more such bridges and tunnels are there across the country? If we compare the amount other nations spend on infrastructure, (think China for example) this bill is woefully inadequate. It almost guarantees that our nation will continue to slip lower on the economic scale, among most nations.
Fortunately, the Democrats are working on a $3.5 trillion budget blueprint that will provide additional spending on climate, health care, and education.
As this quarter's earnings season winds down, it is no surprise that the vast majority of companies beat estimates on both the top and bottom lines. It was to be expected, given easy comparisons and the surge in economic activity. Those earnings are what have propelled the averages to new highs.
Large cap, growth stocks have had a great run recently and seem to me to be a bit over-extended. Some of the FANG stocks experienced a bout of profit-taking this week as well. We will also have passed the Aug. 1 deadline on raising the debt ceiling, which should create some short-term angst among traders. It wouldn't surprise me if we see a mild pullback (3-5 percent) in the weeks ahead, so be prepared.
@theMarket: Wild Week for Stocks
In just one week, the major averages have had a 3 percent swing from lows to highs. These gyrations go hand in hand with the high level of indecision investors are feeling right now. Can you blame them?
Last week, and into the end of the day on Monday, the S&P 500 Index registered a 3 percent decline. In the next few days, all of those losses were recouped and then some. While investors breathed a sigh of relief, I don't think we are out of the woods just yet.
Most strategists blame the decline in stocks on the free fall in yields. The U.S Treasury Ten-Year Bond (the "Tens") fell to 1.13 percent at its lowest point on Monday. At the same time, the U.S. dollar spiked higher and broke through several technical resistance levels. Wall Street traders worried that something "big and bad" might be about to happen.
Equity investors decided to sell first and ask questions later. The fact that we are in the middle of summer vacations didn't help. On low volume days like we have now, traders can push the prices of stocks much higher (or lower) than normal. The one thing I can say for sure is that the actions in the financial markets over the last week were not normal.
Bond yields rarely move in such a wide range in such a short period of time. This week, we have seen yields on the "Tens" move from 1.13 percent to 1.30 percent, and back down to 1.25 percent. Those are massive moods for the bond market.
The price of oil dropped to $65.56 a barrel on Monday, which was more than a 7 percent decline in a single day, but now, just a few days later, that same barrel of oil fetches $71.75. Heck, the price of Bitcoin suddenly appears to be a model of stability compared to some of the moves in stocks, bonds and commodities this week.
Fed policy, interest rates, deflation, inflation, stagflation, and now the upcoming battle over the debt ceiling fills out the list of worries that have investors on edge.
Monday's stock market swoon may have also had something to do with the Coronavirus Delta variant. As I warned readers, the new cases of the Coronavirus Delta variant are surging and should be taken seriously. I'm guessing the fear of the Delta impact on economic growth is finally dawning on investors. But the event I fear most is a vaccine-resistant, coronavirus mutation, spawned from within the huge population of unvaccinated.
We have already witnessed a number of new virus strains that are assaulting the efficacy of our present vaccines. Take, for instance, the recent findings from a team of New York University researchers that the one-shot, Johnson & Johnson vaccine is far less effective at preventing coronavirus infections from the Delta variant and other mutated forms of the virus than from earlier strains. An Israeli study found that the Pfizer vaccine is less effective against the Delta variant than we thought.
What would happen if a future mutation proves to be resistant to any or all of our vaccines? I fear that as long as the majority of the world's population (including 40 percent of the U.S. population) remains unvaccinated, the probability of such an occurrence is increasing every day.
The actions of the market this week make me believe we will see more volatility in the weeks ahead. The main averages may not fall out of bed, altogether, but they could. It's been a long time (last October), since we have had even a 5 percent pullback in the broader market.
So far, we have avoided a general market decline. Instead, we have experienced a series of rolling corrections throughout various sectors. The transportation index, for example, was down as much as 12 percent since May. Some basic material and commodity stocks have also had similar big corrections.
My advice is to get ready for some more weeks like this last one. They may not all end up in favor of the bulls, either, because July into August is usually a weaker period for equities. You might want to consider a vacation in the weeks ahead, and let the markets work out some of their issues.
@theMarket: Week of Surprises Keeps Investors Hopping
There were plenty of reasons why the stock market was a bit jumpy this week. Let's go through them.
Two weeks ago, I wrote that I was worried "that we could suddenly see a spike in new Delta variant cases that impacts economic growth. Remember that less than half of all Americans are fully vaccinated. President Biden, his chief medical advisor Anthony Fauci, and the Fed are all sounding warnings over this risk, yet the markets are ignoring it."
Investors finally caught on this week and began to realize the risk presented by the Delta variant and its impact on the re-opening of the U.S. economy. It is impossible, in my opinion, to maintain the economic pace of recovery in the U.S. and achieve full employment without herd immunity. Herd immunity would require a vaccination total of 70 percent of the population, according to medical experts at the Center for Disease Control.
The radical right, and their elected officials, which represents roughly 40 percent of the population, refuse to get vaccinated, or even follow the most rudimentary medical safeguards. It is partisan politics at its worse. And as a result, in my opinion, the economy will have an extremely difficult time realizing its potential, nor will the United Sates truly recover from COVID-19.
The next news item roiling investors involves the minutes of the last FOMC meeting, released on Wednesday. We already know that the Fed is planning to begin tapering, so it is really a question of when. Fed members were quoted as saying that "they might need to pull back their support for the economy sooner than they anticipated because of stronger than expected growth … ."
Despite Chairman Jerome Powell's assurances otherwise (that tapering would happen later, not sooner), we read that "various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of the incoming data … ."
Investors simply took that to mean that sooner, rather than later, was now the Fed's timetable for tightening. When markets are at record highs, those are the kind of words that can (and did) ignite a decline.
And then we have the worrying yield trend of the U.S. Ten-Year Bond. The yield on the "Tens" fell to 1.25 percent this week. Less than a month ago, the worry was that yields would rise to 2 percent before the end of the year. What happened? It could be that fears of the new Delta variant have forced bond investors to seek safety in bonds, while adjusting the growth rate of the economy downward.
Another concern is that the OPEC-plus members have yet to come to any kind of production agreement. Traders expected that lack of compromise to put even more pressure on prices, but the opposite occurred. Some energy bears say that the United Arab Emirates' (UAE) refusal to back an increase in production has created a potential crack in the solidarity of the oil cartel. In which case, anything could happen.
Finally, the debacle involving the $4.4 billion, initial public offering of Didi, the Chinese ride-share company, has thrown global investors for a loop. Last weekend, a day after the IPO, the Chinese government ordered the company to cease accepting new users and to close down its app. Chinese regulatory authorities are probing whether Didi, as well as other companies, illegally collected and utilized personal data.
In the past year or two, these regulatory probes of Chinese companies have been increasing. Chinese, global growth companies like Alibaba, and its wholly owned subsidiary, financial credit giant, Ant Group, have been ham-strung by the Chinese government's initiative to exert control over social media and how they handle, collect and share data. Regulators in November of 2020, for example, simply halted Ant Group's multi-billion-dollar dual listing in Hong Kong and Shanghai at the last minute.
Didi's share price was down more than 20 percent since its IPO and other large Chinese companies, especially those in social media and e-commerce, have dropped more than 30 percent in the past few months. That has put even more pressure on the markets.
Readers should expect more volatility in the days ahead. There are fewer traders, less volume and more opportunity for algos to move markets up and down at the drop of a hat. It is a good time to take some time off and enjoy the summer weather. Stay invested.
@theMarket: Markets Grind Ever Higher
The S&P 500 Index is up 14 percent so far this year. Most other averages have similar double-digit gains. July is normally a fairly positive month (in general) for equities. Does that mean we can expect equities to continue their bull run through the summer?
It certainly looks that way. Any pullbacks in stocks will likely be met by dip buyers. That could limit declines to a manageable level. A sustained rise in interest rates will likely wait until investors know with certainty the Fed's next move. The thinking is that there will be an announcement on tapering bond purchases, which may not happen until August, or September, if then.
Inflation has receded as a topic of concern for many on Wall Street. The decline in commodity prices has calmed nervous investors worried about runaway inflation. The U.S. dollar has also gained ground versus most other currencies. As a result, we appear to be in a sweet spot for equities.
This week, the NASDAQ, which had been lagging behind both the S&P 500 and the Dow Jones Industrial Average, finally broke to new highs led by the semiconductor index.
The PHLX Semiconductor Sector Index (SOX) is a capitalization-weighted Index of 30 semiconductor companies. The SOX is an important telltale index. It has led the stock market higher throughout the year. I would advise readers who want to know where the markets are going to keep an eye on the SOX as a leading indicator for the markets' direction overall.
But the big story for investors is the continued rise in oil prices. The OPEC-plus producers meeting that was held on Thursday of this week carried over until Friday. One member, the United Arab Emirates (UAE) is objecting to any increase in production and supply because they are not convinced that there will be a strong global recovery, OPEC had planned to increase output in the coming months, but at a slower rate than anticipated. Monthly output increases by OPEC and its allies (including Russia) would amount to less than 500,000 barrels/day between August and December, if the UAE can be convinced to go along.
OPEC members are anticipating that demand for oil will increase by 5 million barrels in the second half of 2021, which could create a further supply and demand imbalance. Oil prices, under that scenario, could rise (some say to as high as $100 a barrel). That would put price pressure on consuming nations, while adding to the risk of higher inflation.
Cynics believe the organization (led by Saudi Arabia) is deliberately engineering this squeeze play to gain back some of the losses incurred by oil producers last year.
Of course, OPEC's consumption forecast of 5 million barrels could fail to materialize and that is what the UAE is worried about. The COVID-19 Delta variant, they believe, is a wild card. A surge in the virus variant could impact global energy consumption far more than expected. In the U.S., gasoline consumption might not be as high as anticipated. And if U.S. and Iran come to a nuclear agreement and embargos are lifted, increased Iranian supply could come back on stream in the months ahead.
As readers are aware, oil was one of my top picks to outperform this year. I still believe energy and energy shares are a good investment, despite the outsized gains of the first half. But buyers beware. Commodities can be great investments, but they also carry great risks. I would wait for a pullback before venturing into the oil patch. Depending on what happens over the weekend at OPEC, you may get your chance.
@theMarket: Inflation Is Running 'Hot'
May's Consumer Price Index (CPI) jumped the most since 2009. That follows a similar gain over the past three months that has brought the total increase to 6.9 percent on an annualized pace.
That is the largest gain in 13 years.
Excluding the notoriously volatile food and energy components, however, the "core" CPI rose by 0.7 percent, which was still larger than the forecast of 0.5 percent. Readers might scratch their head when looking at those numbers, since excluding food and energy makes little sense to us, who are faced with weekly rises in both commodities.
The difference is that the price of chicken or a $3 gallon of gas might reverse at a moment's notice while core component prices are stickier and longer lasting. The underlying cause of these price gains are easy to explain. The economy is re-opening, sparking a rush of consumer demand. At the same time, there are shortages of materials caused by shipping bottlenecks that are leading to higher input costs, including rising wages.
Government stimulus checks and pent-up demand by consumers has led to growing back orders and below-normal inventories of goods. The used car and truck market, for example, is red hot and accounted for fully one-third of the overall increase in the CPI. Consumer product companies, from fast food restaurants to women's clothing stores (and a slew of other enterprises) are ratcheting up prices as demand continues to rise.
As if to underscore this trend, initial jobless claims fell for the sixth straight week to a new, pandemic-era low. More job gains in the weeks and months ahead may fuel this rising tide of consumer demand, and spending. But will it fuel even higher inflation?
Market pundits had predicted if inflation ran hot, investors would get even more anxious that the Fed might tighten, in which case, the markets would tumble, but they did just the opposite. A look under the hood of the core CPI number reveals inflation was not as "hot" as it first appeared. If you subtract the price increase in used cars, which the market considers transitory, the core rate was actually lower than analysts expected.
That gave the Fed's "inflation will be transitory" argument more credence among nervous bond investors. The so-called bond vigilantes responded by driving interest rates lower.
The benchmark U.S. Ten-Year Treasury Bond fell to under 1.50 percent.
The S&P 500 Index had been attempting to break to new highs every other day this week, only to fall back in defeat by the end of each session. The CPI announcement was the catalyst it needed to finally break out of its range to a new, all-time high. The other averages followed suit but failed to make new highs.
Lower interest rates should continue to act as support for the equity markets overall. We are entering the summer doldrums at this point, which should mean a slower tempo to the markets. I expect equities to continue their "two steps forward, one step backward" sort of advance.
The S&P 500 should climb higher (maybe another 40 points or so) through the beginning of next week. The Fed's FOMC meeting is scheduled for mid-week, so investors will be keen to listen for any clues of future monetary policy from Central Bank Chairman Jerome Powell.