A Stroll Down a Confusing Market: Why Nothing Makes Sense
As I have been meeting with clients lately, there seems to be a theme to their feelings on the market. Is the market approaching a top, and is it time to take some risk off the table? There is certainly some pessimism in the air from investors who have seen a pandemic and shutdown, then a reopening and a boom in the economy, and now a new COVID variant gaining steam. It’s……a lot. Right now, see 3 key variables driving investor sentiment: an incredibly strong earnings season from companies who are comparing against last year’s COVID earnings, a bond market with extremely low interest rates, and inflation concerns over fiscal spending coupled with these low rates. Let’s look at each in slightly more detail.
Record Corporate Earnings in the Stock Market
As of July 27th, data from Refinitiv showed year over year earnings growth in the S&P 500 of 79.2%. That’s massive! The industrial sector, which was decimated in Q2 of 2020, grew 627%! Consumer discretionary rose 305%!1 These types of numbers show us two things: that last year’s shutdown was horrible on industries dependent on consumer spending and supply chains (our cyclicals), and things are appearing to return to a more normal level as consumers resume going out and industries get back to production to meet that demand. Can it continue? There are a couple factors I am watching. Firstly, the surge in consumer demand from the reopening has stressed our supply chain, and we have seen that materialize in surges in price for various items (gas and lumber come to mind immediately). There are consumers on a 6-8 month wait on furniture orders. As I drive home from work, I pass auto sales with lots that are 1/3rd full due to shortages in chips for the vehicles. As these stressors subside, supply should increase to meet demand, allowing more people to make those purchases they may be putting off. Second, how much does the Delta variant disrupt our return to “normal” business? I tend to be in the “not much” camp. We are a year ahead now and have learned some lessons from the first surges that shut things down. It seems like businesses are learning to adapt to the conditions and are figuring out how best to still operate and provide service during a pandemic. Technology has leapt forward during the pandemic, and we are learning to live in the “Zoom” society, meeting virtually away from the office and making things more convenient for everyone. While I can’t say for certain how significant the virus will be on a health scale, I can stick to my expertise area and use history to state that businesses that can adapt to their market environment will thrive. That has always been the case in our economy, and that fact makes me feel a little more confident.
As I write this, the current 10-year treasury rate sits at 1.35%. While it isn’t the 0.5% we saw during the height of the pandemic in 2020 as the Fed moved rates to zero and began monetary support by buying up bonds and giving the market liquidity, these are still quite low. Those of you that have been in the process of buying or selling a home (or both!) have felt the benefit and sting both ways from this. On one hand, mortgage rates are very low, and it’s likely you may get a 30-year fixed loan for around 3.5%. On the other hand, it seems like everyone is doing this, as we’ve had a massive surge in home prices as the supply of homes can’t keep up with demand. Can rates fall? They can (to an extent). We can look at bond markets in Europe and see that rates can go negative. I don’t believe we will ever see this from our central bank, but it is “possible.” The dollar is the global reserve currency. 61% of all foreign bank reserves are held in U.S. dollars2. Our central bank is more likely to initiate other measures (such as buying bonds to provide liquidity) before moving the target interest rates into negative territory. However, these rates can absolutely go up, and let’s talk next about how that happens.
With the surge in prices we talked about earlier, inflation seems to be on everyone’s mind. Why is gas so expensive? Why did lumber go up 300% in a matter of weeks? Why are used cars so expensive? Is this "true" inflation? I’m not so sure. Inflation is quickly defined as an increase in the cost of a “basket” of goods defined by economists. However, there’s a lot of things in that basket that aren’t related to each other. There are your basic grocery items (milk, butter, etc.), but there are also more expensive consumer items (furniture, gas, housing costs, etc.). What appears to be inflation by measuring this overall basket may just be supply disruptions in specific areas. Lumber went up, then retreated to a little higher than its previous price level. Oil surged in price but is now falling back to lows. With all these supply disruptions, it is difficult to determine for certain whether this is true inflation, or just a temporary situation that will calm down as things slowly get back to what we are used to. I currently fall into the latter camp. I believe it’s hard to gauge what’s happening with how economists typically calculate inflation, because it doesn’t consider those individual issues well. And, we have never experienced a disruption on this scale in modern markets. With that information in hand, it’s likely better that we let some of this disruption on the supply scale back and see whether things return to a more steady rate. However, should this inflation prove to be sticky, we will absolutely see interest rates rise from where they currently are.
It’s a challenging environment, without question. This secular bull market has been on the run for 12 years, and bond prices continue to hover toward all-time highs. There’s no great place to earn income return with low rates, and we are seeing record levels of fiscal spending. There are several areas in this post that I could break out into future blog posts themselves (actually I may just do that!). If you have questions, want more information, or just want to have a conversation about things, please reach out to me! You can reach me via email at firstname.lastname@example.org, or schedule a phone call or meeting using my calendar link below. Enjoy your week!
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Mitch works at Resolute Wealth Management as a Financial Consultant. Mitch's primary role is to assist in delivering a professional level of service and support to our clients in all aspects of the planning and investment process. Mitch specializes in working with clients to identify life goals and aspirations and in creating investment strategies that assist them in meeting their goals.
Mitch began his career assisting customers through his managerial roles in the retail sector with GameStop and later with Ohio CAT, a dealer network for Caterpillar machinery. During that time, Mitch became passionate about providing a high level of customer service and discovered a passion for working with people. Mitch loves working in personal finance and investment strategy and ultimately decided to change career paths to pursue an opportunity to use these skills to assist families to meet their goals and aspirations. Mitch has 3 years of investment experience with local firms in the Dayton area, where his primary responsibilities were focused on supporting the operations of the firms as they worked with their clients.
Mitch graduated from Wright State University with a Bachelor of Science degree in Finance with a focus on investments, and recently completed his MBA at The Ohio State University Fisher College of Business. Mitch is currently a CFA Level 3 Candidate and is scheduled to sit the exam in November 2021. Mitch currently lives in Fairborn, Ohio with his wife, Lisa.