@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.
@theMarket: A Churn at the Top
It was a sleepy week in the markets for the major averages. Stocks flirted with the old highs, only to fall back by the end of the week. Energy and a few meme stocks occupied most of the attention.
Crude oil spiked higher, nearing almost $70 a barrel (bbl.), pulling energy stocks along with it. Energy traders were heartened by the latest OPEC meeting. The cartel expects demand to outstrip supply by more than a million barrels a day for the foreseeable future. As a result, the members intend to gradually increase production as the global economy gathers steam. Most analysts expect oil to breach $70/bbl. before taking a break.
Certain stocks such as AMC and GameStop, which have been dubbed "meme" stocks by the Reddit crowd of retail traders, had an unbelievable week of gains. AMC, the nation's largest theater chain, for example, saw its stock gain by more than 100 percent in one day. The price rise finally slowed and then reversed after the company announced two consecutive stock offerings over three days.
There is no fundamental reason to justify this kind of price movements. I witnessed the same thing during the Dot.Com boom (and bust) back in the beginning of this century. For those who can ride the bull, I applaud you. I just hope you are lucky enough to exit before you get trampled. Buyers beware.
Investors are also watching the infrastructure negotiations between the two political parties. The horse trading is getting intense. Reports that President Biden might be willing to revise his proposal to increase the corporate tax rate to 28 percent from 21 percent cheered markets. That tax hike has been a major roadblock in winning Republican support for his infrastructure plan.
The Washington Post reported that Biden might consider a minimum corporate tax rate of 15 percent instead. On the surface, that might seem to be a tax cut from the present 21 percent rate. However, few corporations pay the going rate (although politicians like to pretend they do). The actual tax, after all the credits and loopholes in the tax law, usually results in a payment that is a substantial discount to the stated tax rate. Some large corporations pay no tax at all.
Another indication that the U.S. Central Bank sees further signs of economic recovery is that the Fed announced it was preparing to sell its $13 billion corporate bond and ETF portfolio (called the Secondary Market Corporate Credit facility, which it established during the pandemic). Officials made it clear that this was a separate move and should not be considered as a move toward tightening monetary policy.
May's Non-Farm Payroll employment report for May 2021, which was announced on June 4, was the second monthly disappointment in a row. New hires came in at 559,000 jobs. That was far lower than the 675,000 expected, but bad news proved to be good news for the financial markets. Stocks rallied since markets are keenly focused on the "tapering" conversation.
Some Federal Reserve Bank members continue to talk openly about the need to start tapering purchases of fixed income assets. Yet, other "doves" on the FOMC board remain convinced that we need several more months of data before beginning that process. The weak employment numbers give credence to those Fed officials who want to go slow.
Continued, easy monetary policy means interest rates should remain low, which is good for equity assets. And so the stock market rallied on the Non-Farm Payroll "bad" news. At this point, traders are expecting to hear more about tapering from Fed officials after their mid-June FOMC meeting with a possible announcement on when tapering will begin around the Fed's annual Jackson Hole conference in August.
Equity markets, I believe, will continue to be a battle between bulls and bears. While summers are usually a slow period in the markets, I suspect this year we could see further turbulence and possibly further gains. That could keep the pros close to the terminals, since we are quite close to historical highs on the S&P 500 Index. A break above them (at 4,238) would give the bulls clear sailing to 4,300. The question is what new piece of news could trigger that breakout?
The crypto currency market, on the other hand, remains subdued. Bitcoin continues to trade in a range between $33,500-$38,000. Technicians seem to be biding their time before making a move. Many believe Bitcoin must either break decisively below $33,000 to sell it, or above $40,000 for new purchases.
In the commodities corner, copper, gold, and silver took it on the chin this week after the U.S. dollar bounced off three-week lows, while oil continued to rally. Volatility like this is the name of the game when investing in crypto currencies, commodities, and commodity stocks. There is a saying "If you can't stand the heat, get out of the kitchen," so invest accordingly.
@theMarket: Inflation Fears Weigh on Investors
Most stocks took it on the chin earlier this week. Technology shares lead the rout, but it didn't take long before just about everything else followed tech lower. By the end of the week, it was as if nothing had happened. That's called "chop." Get used to it.
The Consumer Price Index (CPI), which investors use to gauge future inflation, took the lion's share of the blame for the downdraft in equities. Economists had warned that we should expect a higher monthly reading (0.2 percent) for April, but the data came in at 0.8 percent. That computes to a 4.2 percent price gain year-over-year and was almost triple the rate that anyone had expected.
The market reaction was swift. Interest rates spiked higher along with the dollar, while equities dropped. The carnage continued for three straight days, taking the S&P 500 Index down 4.2 percent from its high of 4,238. Traders waited until the index hit its 50-day moving average at 4,056 before buying the dip. A relief rally on Thursday and Friday repaired about half the damage.
The CPI shock was not a one-off, statistical aberration, however. April's Producer Price Index (PPI) was also released this week, showing a jump of 6.2 percent versus a year ago. That was the largest increase since the Bureau of Labor Statistics started tracking the data in 2010. The monthly increase of 0.6 percent was twice the expected gain.
Economists were quick to explain that the numbers were not as bad as they appeared, since a year ago the economy was in a free fall. Prices were at their lows during the pandemic, so comparisons were bound to be stronger than expected and will continue to be so for the next several months. They have a point and investors seemingly calmed down a bit.
Over the past few months, the fear of uncontrolled future inflation, fueled by governmental stimulus and a growing economy, has been a primary concern among traders. There is presently a tug of war between the Fed, which believes that this spike in inflation will be transitory at best, and the inflation bears who argue that there is no such thing as transitory.
This week, the market algo computers sold stocks on the CPI news and it took cooler heads a day or so to prevail largely on the news that the Center for Disease Control (CDC) announced they were lifting inside mask restrictions for those who have been vaccinated. That revived the bulls, who piled into the re-opening trade once again
I had written last week that the best investors could expect from the markets over the next few weeks would be marching in place. I warned that there was also a real possibility we could experience a 5-10 percent decline in the S&P 500 Index and worse in the NASDAQ. Well, this week we lost almost 5 percent in the benchmark S&P 500 and closer to 10 percent in a lot of technology stocks. Some of those high-flying, next generation stocks with no earnings or sales have experienced a 30-50 percent pull back in the last few weeks. Some may be tempted to get back into these names but now is not the time, in my opinion. Better to focus on value and cyclical stocks that have real earnings, dividends and a strong balance sheet.
It is after all, the month of May, and so far it has lived up to the admonition to "sell in May." It is quite possible that we will see the same kind of chop in the markets for a while. If so, I advise readers to sit on your hands, do nothing and ignore the noise. Otherwise, it could be you who ends up on the chopping block.
@theMarket: Stocks Make New Highs
It has been the best quarterly earnings season in a long time. More than 87 percent of companies that have reported thus far have beat earnings estimates. That is a record and investors celebrated.
Last week, I mentioned that this earnings season has been a classic example of a sell-on-the-news. It has been especially so for companies in the technology sector, but not so much for investments in other areas. What, you might ask, does this say about the overall markets?
The most bullish interpretation is that we will continue to move higher making new highs after new highs. The Dow Jones Industrial Average made yet another new high yesterday, as did the S&P 500 Index. The NASDAQ is still off by 4 percent from its highs and the small cap Russell 2000 Index is off by 6 percent.
However, for the year thus far all the indexes have positive gains. The S&P at 12 percent is about ties with the Dow, while the small cap Russell and the technology-heavy NASDAQ are lagging. I have been warning investors since the beginning of the year that technology, especially the stay-at-home stocks, would be underperformers.
As we enter the second week of May, with the markets at, or close to, all-time highs, investors need to ask how much of the present macroeconomic data is already reflected in the price levels of the stock market. We know that coronavirus cases are falling and will probably fall further. We also know that this quarter and next will see economic growth spurt higher, while unemployment drops. I feel it would be safe to assume that the market has already discounted some of those future expectations.
However, don't think that Wall Street economists get it right all the time. Take April's unemployment report. Forecasts were for the economy to gain one million jobs last month. Instead, only 266,000 jobs were added. That was the largest miss since 1998. It immediately cast doubt on the timetable of economic recovery.
Expectations are that the economy is going to roar back, and with it corporate hiring plans. Friday's report, if anything, might reduce some of the more bullish enthusiasm of some financial analysts. That is a good thing, in my opinion.
The prospect for higher inflation is still a question mark, as is the future course of interest rates. Those two variables are interconnected and will occupy our attention for the foreseeable future. Sectors that benefit from inflation, like commodities, are outperforming. I expect they will continue to do so as the economy recovers. So-called “value' areas like industrials, transportation, and materials, as well as financials, have also done well and should also continue to gain, even if interest rates move higher.
The sectors that are hurt by inflation or higher interest rates, however, should underperform. The result could be a bifurcated market, something I believe we are witnessing at times right now. I am expecting markets to climb a little higher. My target for the S&P 500 Index is between 4,220 and 4,270. At this rate, we should hit my target by next week.
At that point, those invested in the three main indexes, you could see markets simply pause in the weeks ahead and trade in a range. That would be my most bullish scenario. The bearish story would be a classic May sell-off of possibly 5-10 percent. If that were to occur, the good news would be that the stronger sectors might mitigate some of the downside potential in the weaker areas.
I will be watching the transportation and energy sectors for clues. Those two areas should continue to gain if investors believe the re-opening trade is still intact. Weakness might indicate economic prospects have been fully discounted, in which case, the markets should follow their lead downward. Stay tuned and keep reading.