by William Henderson, Vice President / Head of Investments
Last week the markets showed conditions remain favorable for equities as easy financial conditions and a healthy economic recovery are firmly in place for the foreseeable future. All three major indices posted strong weekly returns adding to their very healthy year-to-date gains. The Dow Jones Industrial Average rose by +3.4% last week, the S&P 500 Index rose +2.7% and the NASDAQ increased by +2.4%. The “value-over-growth” trade seems to have waned as the major indices have moved into relative parity on a year-to-date basis. Year-to-date, the Dow Jones Industrial Average has returned +13.6%, the S&P 500 Index +14.8% and the NASDAQ +11.8%. Bonds continue to be well bid with yields remaining stubbornly low. The 10-year U.S. Treasury dropped six basis points last week to end at 1.51%. 

Three additional factors boosted the markets. First, all 23 major U.S. banks including J. P. Morgan Chase, Bank of America, and PNC Bank passed the Federal Reserve’s annual stress tests, which are designed to test the resilience of large banks under severe global recessionary conditions. Second, after several weeks of negotiation, President Biden and a bipartisan group of senators announced an agreement on an infrastructure deal that could carve out up to $1 trillion from the $2.25 trillion American Jobs Plan that was released in March 2021. The agreement focuses on traditional infrastructure such as roads and bridges as well as water infrastructure and broadband internet access. The deal is a positive development because it comes with no new taxes and instead is funded by hodgepodge of revenue sources including repurposing unused pandemic relief funds, tougher Internal Revenue Service tax collection, and selling oil from the Strategic Petroleum Reserve. And third, inflation fears are modestly abating as supply chain pressures have eased and prices for basic commodities, including metals and lumber, fell from their recent spikes.   

It is important to keep inflation concerns in the proper perspective. The chart below shows the long-term U.S. Core PCE (Personal Consumption Expenditure) year-over-year percent change. The recent jump in U.S. Core PCE of +3.4%, is not that significant when you look at inflation over a much longer term. The Fed’s goal of +2.0% average annual inflation remains in place, which means rates remain low for longer. 

U.S. Core Personal Consumption Expenditure (PCE) 

(Source: Bloomberg & Goldman Sachs June 2021) 

As we move to close the second quarter, corporate earnings announcements most likely will surprise to the upside and revenue growth will remain robust. However, companies may have to deal with cost increases due to supply chain disruptions and higher wages going forward. The economic tailwinds for the second half of 2021 will be consumer driven rather than stimulus driven.   

Consumers are in excellent financial shape with personal savings accounts at record levels. According to the Federal Reserve Bank of St. Louis, M2, the money supply measure that includes cash, checking deposits and money market funds, reached $20.3 trillion on June 22, 2021 (See chart above). There is massive pent up demand for travel and leisure; and with summer upon us, watch for the consumer to fuel the economy and the Fed to keep the pump primed. 

by William Henderson, Vice President / Head of Investments
Last week, the markets saw negative returns after posting positive gains for several consecutive weeks. Of the three major indexes, the Dow Jones Industrial Average saw the biggest weekly decline, and the largest decline for that index in more than eight months. Value-style stocks once again underperformed growth stocks as the NASDAQ saw only a modest pullback. For the week that ended June 18, 2021, the Dow Jones Industrial Average lost -3.5%, the S&P 500 Index fell by -1.9%, and the NASDAQ fell by only -0.3%. Modest pullbacks are to be expected in any healthy stock market and last week’s negative returns did not significantly chip away at this year’s strong year-to-date returns. Year-to-date, the Dow Jones Industrial Average has returned +9.8%, the S&P 500 Index +11.7%, and the NASDAQ +9.2%. Bonds had a quick reversal during the week, with the 10-year U.S. Treasury initially spiking to 1.57% after the Federal Open Market Committee (FOMC) announcement about interest rates (more on that below) but calmed down by week’s end to close at 1.44%. (See the 5-day chart below of the U.S. 10-year Treasury Note – CNBC) 

The news of the week was certainly the FOMC meeting and the follow-up press conference by Chairman Jay Powell. The Fed raised its inflation forecast, and a dot plot of individual central bank members’ expectations on policy, signaled that an interest hike could happen sooner than expected, in 2023. Investors typically get spooked with the mention of higher interest rates, as cheaper (lower) rates help to spur economic growth. Further, St. Louis Fed President James Bullard told CNBC on Friday that he expected an initial rate increase to happen even sooner in 2022. “We’re expecting a good year, a good reopening. But this is a bigger year than we were expecting, more inflation than we were expecting,” Bullard said on CNBC’s Squawk Box. “I think it’s natural that we’ve tilted a little bit more hawkish here to contain inflationary pressures.” That comment was in direct contradiction of Powell’s press conference comments that higher interest rates were not expected until 2023-24.   

Clearly, the markets are seeing the trends. First, global stimulus in the form of dollars to consumers is fading, which will lead to a contraction in in M2 (supply of money and savings). Second, the temporary demand/supply imbalances are ebbing allowing commodity prices to stabilize (lumber, critical for new building, led the way lower – see chart below from the Federal Reserve Bank of St. Louis). 

Third, the global economic rebound is continuing and now includes the Eurozone. These trends overall are positive for the market and continued economic growth, but they also point to inevitably higher interest rates in the not-to-distant future. The Fed will watch for inflation, which thus far has appeared (as mentioned last week, with the 5% jump in the Consumer Price Index). The question remains about whether the inflation will be transitory or more permanent. For us, the picture remains clear: last year featured collapsing global growth and massive stimulus. Looking at 2021-23 we see healthy growth and a cooperating Federal Reserve that is timid about raising interest rates too quickly.