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The global spread of COVID-19 has caused significant market movements and uncertainty among investors.

Your investment brief houses our experts' latest analysis and strategies for navigating the turbulence created by the outbreak—keeping you updated on our thinking and how these changes might impact your portfolio.

Key Private Bank Investment Briefing Notes

Monday, 7/26/21

General Takeaways:

As we noted in last Friday’s comment, the National Bureau of Economic Research (NBER) dated last year’s recession as the shortest on record, beginning in February 2020 and ending just two months later.

During the ensuing economic recovery, the S&P 500 rose 48% between April 2020 and June 2021. These returns are among the strongest of any expansion in the last nine decades. Only the expansion that began in 1933 showed stronger initial returns.

Evercore ISI Company Surveys are booming. Retail sales momentum continues, and companies are reaping the benefits. This data is consistent with very strong corporate earnings (discussed below). However, inventories remain very low, which could cause future supply issues.

On Friday, the Employment Cost Index (ECI) will be reported. This number is an important inflation metric. Expectations are for a 5% increase, which would be the most significant increase for many years but not unprecedented.

COVID-19 update: cases in Israel are beginning to rise, even amongst the fully vaccinated. Thankfully, hospitalizations and fatalities have not increased significantly. A flare-up in cases in the Jiangsu province of China is also prompting some concern, as China’s approach to COVID has been “isolate and control” from the beginning.

Within the United States, COVID-19 cases and hospitalizations are on the rise, especially amongst the unvaccinated. First dose vaccine administrations are showing signs of bottoming after weeks of steady decline.

Credit spreads remain a critical indicator for the health of the overall market. They have remained primarily stable over the past few weeks despite the recent uptick in equity volatility – details below.

Equity Takeaways:

US large cap stocks were essentially flat in early trading on Monday, while small caps rose about 1%. International shares were generally lower, led by weakness in emerging market stocks.

The S&P 500 hit another all-time high last week. It has been 179 trading days since the last 5% drawdown in the S&P 500. Since 1929, the average period between 5% drawdowns has been 94 trading days.

24% of S&P 500 companies have reported 2Q:2021 earnings. On average, revenues are coming in 4% above expectations, a record going back to 2008. 86% of companies have beaten revenue expectations.

The S&P 500 appears poised for 20%+ aggregate earnings growth during the quarter. 88% of reporting companies have reported earnings above expectations, with the average beat 19% above analyst estimates.

Key Private Bank believes the equity market is currently in a mid-cycle transition phase. We expect a choppy market over the next few months. As bond yields have fallen over the past few months, growth stocks have reasserted market leadership. We expect this dynamic to continue throughout the third quarter of 2021.

In the fourth quarter, once the “summer doldrums” are complete, we expect the reflation trade to reassert itself. Cyclical sectors like financials, industrials, materials, and energy have lagged over the past several months – we believe these sectors will likely reassert leadership in the fourth quarter.

Earnings estimates for the rest of 2021 and 2022 are probably still too low, but expectations are high, so it is important that realized earnings continue to show strength. Based on where credit spreads and equity valuations are currently, we believe that equities still hold good relative value to bonds.

Market leadership (breadth) narrowed in 2Q:2021. When breadth narrows, active managers tend to have a tough time outperforming the indices.

Emerging markets will continue to be driven by the outlook in China. The Chinese government has been cracking down on any sector that appears to be “hot.” Recent examples include a crackdown on companies that provide online tutoring, as well as a recent hike in mortgage rates for first-time homebuyers.

Fixed Income Takeaways:

The 10-year Treasury yield was 1.29% in early trading on Monday, 1 basis point higher on the day.

Investment-grade (IG) credit spreads moved 8-12 basis points wider last Monday in conjunction with the selloff in equities but tightened throughout the rest of the week to close mainly unchanged on the week.

Last week was a light one for new IG corporate bond issuance, as many investors were likely spooked by last Monday’s volatility in credit spreads.

The Federal Reserve Open Market Committee (FOMC) is set to meet again this week. At this meeting, the Federal Reserve (Fed) is expected to further hint at the tapering of bond purchases, but no explicit updated guidance is likely to be given.

The Fed will not be releasing an updated set of economic projections after this meeting. This fact will likely allow Fed Chairman Jerome Powell to control the post-meeting messaging. Powell remains one of the more dovish members of the Committee.

Within actively managed fixed income funds, active managers tend to outperform the indices when credit spreads are tightening and vice versa. Credit spreads narrowed in the second quarter of 2021. Thus, most active managers showed strong relative performance during the quarter.

Friday, 7/23/21

General Takeaways:

In last week’s Key Questions, Key Private Bank’s Chief Investment Officer, George Mateyo, discussed the National Bureau of Economic Research (NBER) and their method of dating recessions, noting that the NBER had yet to officially declare the end of the 2020 recession. This week, the NBER determined that the 2020 recession lasted two months from peak to trough (February 2020 to April 2020), making it the shortest recession on record.

The housing market remains robust. In June, housing starts increased 6% over May levels, driven by low mortgage rates. 30-year mortgage rates continue to hover near all-time lows, last checking in at 2.98% on average.

Lean inventories and supply chain constraints are creating strong demand for transportation – Evercore ISI Trucking Survey data confirms this trend. This trucking survey tends to correlate with US real GDP growth.

The Conference board is projecting year-over-year real GDP growth of 6.6% in 2021. The Leading Economic Index (LEI) rose 0.7% in June, after increases of 1.3% in April and 1.2% in May. Economic growth remains strong but appears to be slowing. As George Mateyo noted in the aforementioned Key Questions article, the economy seems to be transitioning from an early-cycle “V-shaped” recovery to a mid-cycle phase of more moderate growth.

Cryptocurrency items of note: the SEC said this month that it would seek public comment on WisdomTree’s proposal to launch a bitcoin ETF. The SEC is also looking at new regulations to help prevent fraud in the cryptocurrency markets. Several regulatory bodies are looking at updating the accounting rules surrounding cryptocurrencies held on corporate balance sheets.

Equity Takeaways:

US markets rose in early trading on Friday. The S&P 500 rose about 0.4%, while the Nasdaq rose about 0.25%. Small caps also rose about 0.25%.

The Nasdaq is currently trading at all-time highs, and the S&P 500 is once again approaching an all-time high. The recent dip in bond yields has provided support for technology stocks, which have resumed market leadership. Value stocks have significantly lagged growth stocks over the last several months.

This week, the focus in the market shifted from “peak growth” fears and concerns about the Delta COVID-19 variant back to earnings season, which is off to a strong start. After a sharp dip on Monday, stocks staged a solid snapback rally throughout the week.

Back in April, over 90% of S&P 500 stocks were above their 50-day moving averages. Currently, less than 50% of S&P 500 stocks are above their 50-day moving average. Breadth has been declining, and the largest stocks are supporting the averages.

Earnings season: 111 of 500 S&P companies have reported second-quarter numbers. 82% of companies have beaten revenue estimates, with 87% beating on the bottom line. In addition, commentary from management has been optimistic about the outlook, with few companies reporting a business impact from the Delta variant. In addition, profit margins remain robust, indicating that companies are passing their increased labor and material costs through to consumers.

A mean reversion pause for stocks could be driven by various factors, with the most likely being a slowdown in economic growth and corporate profits. Less likely scenarios include a more hawkish (less accommodative) Federal Reserve (Fed) or a return of disinflation/deflation.

The European Central Bank (ECB) made a few subtle changes to their long-term guidance, resulting in more accommodative policy for a longer period. The ECB stated that they would rather raise rates too late than too early (this is a change from their stance after the 2008 Great Financial Crisis).

Fixed Income Takeaways:

The 10-year Treasury rate was trading at 1.30% in early Friday trading, about 2 basis points higher on the day.

A combination of fundamental (slowing growth and stimulus) and technical factors has driven rates lower than expected in a short period of time. Likely, interest rates will once again begin to drift higher as we head through the remainder of 2021.

There is currently a dearth of single-A and higher-rated paper available in the corporate bond market. More and more issuers have taken on cheap debt, resulting in credit downgrades. About 51% of the investment-grade credit market is rated BBB. With debt costs so low, many companies have made the conscious decision to increase leverage.

The Fed is likely to begin removing monetary accommodation sometime in 2022. The market is expecting a formal announcement of asset purchase tapering in December 2021.

Over the past week, investment-grade (IG) corporate bond funds saw their first outflows in many weeks. All three major corporate bond asset classes (IG, high-yield, leveraged loans) each saw outflows – this is the first time all three saw outflows in the last 18 weeks.

Conversely, municipal bonds continue to see inflows and have seen positive flows in 61 of the last 62 weeks. The fundamental picture in the municipal bond market remains solid, with state revenue normalizing after the pandemic. However, municipal bonds are expensive relative to treasuries on virtually all historical metrics.

Monday, 7/19/21

General Takeaways:

A few weeks ago, we listed several items to consider for the second half of the year; and it appears many are unfolding and worthy of continued monitoring:

  1. Delta variant and continued vaccination challenges
  2. Inflation pressures are building (energy, commodities, and wages = margin pressures and lower earnings)
  3. Economic growth and fiscal support peaking (transition, not turmoil in our view)
  4. Policy error: Fed miscommunication, tax policy, or regulatory over-reach
  5. China slams on the brakes on their economy and their companies
  6. Sentiment/Valuations, and some feelings of complacency
  7. Something else we don’t know/aren’t thinking about

One week does not a trend make, but there may be some signals in last week’s stock market declines. Indicators favor a focus on quality as large cap stocks outperformed small cap stocks.

This quarter’s earnings season might need to be perfect. Last quarter, approximately 90% of companies that reported earnings exceeded expectations. For stocks to continue working in the near term, this trend may need to continue. Given the focus on inflation, the outlook for margins will be an essential data point to assess.

Stocks have historically paused after an earnings peak, but not a reason to panic. Cycles in 1993, 2004, and 2009 all experienced short-term declines in S&P500 market returns in the subsequent six months; however, returns were strong in the following 12-36 months.

There is a disconnect between current interest rates and inflation relative to other times in history. In past periods when inflation was higher than usual (US Core CPI near 4%), 10-year bond yields were in the 5-8% range. The 10-year Treasury yield is currently at 1.3%. This is an unusually abnormal period, and Fed policy regarding the pandemic economic recovery may need to reflect this environment carefully.

Credit spreads are at/near all-time lows, and there is an open question as to how long this might persist. Particularly in the Investment-grade (IG) space, spreads are at about 111 basis points above Treasuries, near an all-time low. High-yield spreads are also low at 314 basis points (bps) above Treasuries, levels not seen since 2007.

Some transitory inflation indicators might become more structural. Consumers’ mindsets are shifting relative to the demand for goods and services, and inflation expectations one year ahead are at 4.8%. Further out into the future, 3-year and 5-year expectations are still elevated at 3.5% and 2.9%, respectively, compared to the last five years.

The cure for higher prices is higher prices – and higher prices are causing demand destruction in certain areas as consumers protest mark-ups. The University of Michigan consumer surveys on a good time to buy a house or a car indicate both are down sharply. US house sales have stalled, despite record-low mortgage rates, because of surging prices. And now, with lumber production greater than lumber new orders, lumber prices are crashing, so perhaps the CPI surge will turn out to be transitory. We believe wages will be the key.

Optimism is generally evident within the economy, especially within small businesses. In addition, optimism is showing via the general public’s receptivity to re-engaging in everyday activities such as dining out, returning to work, staying at a hotel, and using public transportation.

Regarding the Delta variant and vaccination challenges, cases and hospitalizations are again rising in the US and globally. There is a disparity between states with lower fully vaccinated rates seeing a recent higher spike in new cases and those with higher fully vaccinated rates experiencing fewer new cases in the US.

The most concerning resurgence of COVID has been in the UK. This is because the UK is the second farthest along among developed countries in getting vaccinated. Despite this, infections in the UK have surged back close to January 2021 highs. Notwithstanding higher cases, fatalities remain low. Moreover, cases are rising more slowly in the age 70+ population group as arguably these individuals have been vaccinated at a higher rate relative to their younger peers.

Bottlenecks in construction supplies are creating longer lead times in real estate development. The industrial sector has had very high demand from several trends, including e-commerce, the need for data centers, and logistics hubs. Strong demand existed throughout the sector over recent years, and COVID accelerated it.

A 24% increase in materials and lead times have increased to 12-18 months to develop industrial buildings where it has historically been 8-10 months, leading to a tight market. This constrained supply in an environment of increasing demand has been bullish for commercial real estate. The existing buildings needing to keep up with replacement costs also provide a favorable backdrop.

Equity Takeaways:

Stocks fell in early trading on Monday. All three major indices declined, with the S&P 500, Dow Jones Industrial Average, and Nasdaq all being down about 1.3%, while small caps declined 2.0%.

Markets are trading lower due to the Delta variant increase and the potential impact for a successful re-opening of the economy. This dynamic paints a significant conundrum for public health decisions as the risks need to be considered regarding vaccinations. There is not an easy solution for government officials to address those who refuse to be vaccinated.

The S&P 500 last week endured a 1% weekly loss and finished at its lows – marking the first close on its lows since June 18th. Downside follow-through during most recent selloffs has been lacking, and we haven’t seen a 3% drawdown since mid-May.

Earnings season is likely to bring more volatility. Expectations set the bar at a point to be beaten. However, the key to continued momentum will be guidance on upward earnings revisions and is a prerequisite to a higher market.

We still believe we are in a mid-cycle transition. Also affecting the market environment, the period from the second week of July to the second week of October has historically tended to be the weakest market period of the year. So together with the mid-cycle transition, there is a recipe for potential weakness.

Market breadth turned negative last week, with 70% of the S&P500 down for the week. Sixteen names dropped more than 10%, and ninety stocks fell more than 5%; on the upside, zero were up more than 10%, and only one stock was up more than 5%. Small caps were down over 5% for the week.

Fixed Income Takeaways:

Rates markets are rallying with a risk-off mode. The 10-year Treasury is down about 7 bps, dropping below its July 8th low, currently at 1.22% and below its 200-day moving average. A double-bottom is in sight at levels of 1.19%/1.21%. These levels are significant to see if investors take a stand at that level or if yields fall further to the next support level at 1.15%. The 30-year Treasury is down sharply to 1.84%.

We see a pronounced bull-flattening bias on the yield curve. We saw it last week, and it is more pronounced today. In fact, we saw the long-end rally last week after another strong Consumer Price Index (CPI) print and Fed Chair Powell’s commitment to accommodative monetary policy at his testimony in front of Congress. With no Federal Reserve members speaking due to the blackout period in front of next week’s FOMC meeting, it might help stabilize the market.

With the movement in Treasuries, credit markets have also not been spared, albeit spreads have been relatively orderly. OAS stand at 86 basis points, the widest level since May 21. However, we have talked about spreads being in this tight range in the low-mid 80s since April. Yields remain in stable range for investment-grade (IG) bonds. High-yield spreads were unchanged on Friday but were also out 15 basis points last week.

Supply is supposed to pick up this week, with syndicate desks estimating $15-20 billion in new issue IG supply for the week. Yet, some issuers may delay coming to market to avoid some of the volatility today. July volumes for new issuance are at $47 billion. With two weeks left to go in the month, estimates are at $90-100 billion for the entire month. Those numbers are subject to change as spreads are getting volatile. The environment continues to be very favorable for issuers to come to market.

Friday, 7/16/21

General Takeaways:

Five topics for today:

  1. Inflation

    - The headline Consumer Price Index (CPI) rose 0.9% in June and 5.4% year/year – both were the largest increases since mid-2008.

    - Core CPI (excluding food and energy prices) rose 4.5% year/year, the largest increase since 1991.

    - Some of these increases are likely a recovery from last year’s declines. If higher inflation expectations were to become embedded in consumer behavior, however, some of these recent increases could prove longer lasting than expected.

    - Federal Reserve (Fed) Chairman Jerome Powell testified to Congress this week. He said that “inflation has increased notably and will likely remain elevated in coming months before moderating.” He did not signal an imminent change in monetary policy, noting that the standard of “substantial further progress” in the labor market is still some time off.

    - Shelter costs, motor fuel prices (including gasoline), used car and truck prices, and transportation costs (including airline prices) were the four major contributors to the recent spike in inflation. The spike in used car prices is likely transitory. However, an increase in shelter costs could prove “stickier” over the long term.

  2. Economic Progress

    - The Fed’s monthly Beige Book report was released this week. Many Districts reported that firms continue to have difficulty finding workers, and that labor market tightness is expected to continue into the fall – a tailwind for wages.

    - Another sign of an improving labor market: weekly unemployment claims continued to fall, coming in at 360K vs. 386K the week prior. Continuing claims also fell.

    - June retail sales rose 0.6% month/month, vs. expectations of a drop of 0.4%, showing continued strength in consumer spending.

  3. COVID-19

    - The US is averaging about 23,000 new cases per day, about twice the average from three weeks ago.

    - According to the Center for Disease Control (CDC), about 58.8% of American adults are fully vaccinated.

  4. Corporate Earnings (see equity section)

  5. Chinese GDP

    - 2nd quarter Chinese GDP rose 7.9% year/year, down from the prior quarter due to base effects, but still a very strong showing given that China’s economy held up much better than most during the pandemic.

Equity Takeaways:

Stocks rose slightly in early trading on Friday. The S&P 500 rose about 0.2%, while the Nasdaq rose 0.5%.

Small caps reacted favorably to the strong retail sales report this morning, rising 0.7%. Small caps tend to have a more domestic focus than large caps and are thus more sensitive to the US economy.

Markets tend to be forward looking, and much of the recent strong economic data is from June. US markets continue to exhibit strength, but other markets around the world are diverging by exhibiting weakness over the past month, and bond yields remain low.

Second quarter earnings season has kicked off with solid bank results. Market participants are expecting a strong earnings season to support equity prices and help resolve some of the divergent signals noted above.

Christine Lagarde of the European Central Bank (ECB) noted that the ECB will likely revise its forward guidance for its quantitative easing program in the coming weeks. The ECB will likely continue with aggressive easing for the foreseeable future.

Conversely, the Bank of England (BOE) seems to be becoming a bit more hawkish. Recent inflation numbers have been higher than expected in England.

Chinese regulators continue to squash initial public offerings for Chinese companies attempting to sell shares outside of China. China is seeking to control the data that these companies generate. Chinese regulators are also seeking to increase competition within the tech sector.

Fixed Income Takeaways:

We saw strong volume in the new issue corporate bond markets this week, with over $30B of new investment-grade (IG) deals priced. Deal flow was driven by several large financial service companies.

Environmentally and socially conscious bond issuance continues to increase. We are on track for the biggest issuance year on record in this space.

High-yield spreads moved about 7 basis points wider this week. CCC-rated paper is trading about 60 basis points wider than the tightest levels of earlier this year. Conversely, IG spreads have remained very stable since April.

Municipal bond funds continue to experience strong inflows. After two quiet weeks, the new issuance calendar picked up this week as well, with supply rising to meet demand.

Secondary trading in the municipal market remains thin. Longer-dated municipals drifted about 2 basis points wider this week in light trading.

Monday, 7/12/21

General Takeaways:

Currently, there is significant noise around state-level COVID-19 data. Some correlation seems to exist between lower vaccination levels and higher case counts, but the results are not uniform.

The bottom line is that COVID-19 deaths have fallen significantly since the pandemic's peak, but the overall vaccination rate has slowed. According to Bloomberg, herd immunity (75%+ population vaccination) will take an additional nine months in the United States at the current level of daily vaccination. This timeline has been extended and is a bit longer than expected.

The laggards of 2020 are leading in 2021. According to Evercore ISI survey data, both airline and commercial real estate companies continue to report improving sales. In addition, overall retail sales are showing continued strength, with retailers maintaining very strong pricing power.

Survey data also indicate an improving situation for state tax receipts (a tailwind for municipal budgets). A low inventory to sales ratio also means continued tight supply across retailers.

This week, Consumer Price Index (CPI) inflation will be reported. Expectations are for a 5.1% year/year rise in headline CPI, with core CPI expected to rise 4.2% year/year. The CPI is not the Federal Reserve’s favored metric of inflation. Nevertheless, we expect this number will receive significant attention in the press, as we are currently seeing the highest core CPI readings recorded since the turn of the millennium in 2000.

As noted on Friday, China cut interest rates for the first time in many years. China had a small nominal growth recession in 2015. China has been cracking down on large technology companies, so this rate cut could be an attempt to forestall a slowdown in growth by stimulating credit (perhaps to prevent a situation similar to their 2015 slowdown).

Equity Takeaways:

The S&P 500 opened essentially flat in early Monday trading, while small caps fell about 0.7%. The Nasdaq rose about 0.2%.

One of the most important questions for stock prices going forward – will actual earnings continue to beat estimated earnings? Expectations for earnings growth in the remainder of 2021 are very high. 63% year/year earnings growth for Q2 2021 is expected.

Analysts tend to take a "wait and see" approach on earnings revisions, so it is quite possible that their 2Q 2021 estimates are too low, and earnings will come in significantly higher than expected. Based on recent trading, it appears that market participants are expecting such a scenario.

Last week the S&P 500 rose about 0.4%, it's third consecutive all-time weekly high. Despite choppiness, the market remains optimistic heading into earnings season.

Breadth was mixed last week, with about 50% of S&P 500 stocks advancing. Despite this mixed trading, Friday was a strong day which brought the cumulative advance/decline line to an all-time high – confirmation of the bullish trend.

The private equity market has entered "ludicrous" mode, with deal flow continuing to increase. Buyout multiples have remained stable, but debt loads are growing on the average deal. The public markets remain wide open – going public is becoming a more common exit strategy for private equity deals.

Fixed Income Takeaways:

After trading as low at 1.25% last week, the 10-year Treasury yield has drifted back up to 1.35% as/of Monday morning. Rates were essentially flat in early Monday trading.

Another example of the current low-yield environment: the current yield on the investment-grade (IG) corporate bond index is below 2%, below the average 10-year Treasury yield from 2000 to the present.

IG corporate spreads traded in a one basis point range during the entirety of last week, between 82 and 83 basis points (bps). Spreads have remained in the low-80s range since mid-April.

As we proceed through earnings season, we expect continued heavy issuance of corporate debt. Companies generally cannot issue bonds during their earnings blackout periods. Any temporary decline in supply could provide another catalyst to drive spreads even tighter.

Federal Reserve (Fed) Chairman Jerome Powell is set to testify in front of Congress on Wednesday and Thursday. Powell remains one of the Fed’s most dovish members and continues to believe that many aspects of the current inflation spike are transitory.

Friday, 7/9/21

General Takeaways:

Events this week highlighted several points from Tuesday’s Investment Brief:

Much of this week’s market volatility can likely be traced to a “growth scare,” as investors question the strength and duration of the economic recovery. We believe the economy is in transition, likely from early-cycle to mid-cycle dynamics, but no recession is imminent. Transitions in leadership can cause short-term volatility but should not lead to market turmoil in our view.

In addition, headline risk between China and the United States will likely continue indefinitely. This week was no exception, with the Chinese government launching a cybersecurity probe into a large, recently listed Chinese company.

Why are long-term interest rates falling? (point and counterpoint)

  1. Economic momentum is moderating.

    - We believe growth is still positive and could surprise on the upside due to excess savings.

  2. Inflation expectations are moderating (Federal Reserve becoming more hawkish).

    - If the Fed erred by becoming too hawkish too quickly, we anticipate it is a mistake that can be reversed.

  3. Quantitative Easing (QE) / Bond Buying (Federal Reserve suppression of interest rates).

    - We think QE also limits contagion risks.

  4. Fears of a possible “fiscal cliff” in 2022 due to political gridlock leading to recession.

    - We believe this scenario is unlikely.

  5. COVID-19 delta variant concerns.

    - COVID-19 has not been fully eradicated, but we foresee broad shutdowns as unlikely, and fatalities have remained low during the recent uptick in cases.

  6. Crowded trades/sentiment leaning too far in one direction.

    - Sentiment reversals tend to be temporary. We interpret elevated sentiment as usually a good sign, as it means investors want to buy stocks.

Equity Takeaways:

Global stocks rose on Friday after selling off on Thursday. The S&P 500 rose 0.7% in early trading, while small caps rose 2%. International shares also rose.

European shares rose over 1% on Friday in response to a new inflation framework from the European Central Bank (ECB). The ECB will now explicitly target 2% inflation over a full cycle, which essentially means they will allow near-term inflation to drift over 2%. This new framework is designed to support economic growth.

Conversely, Asian shares continue to lag due to COVID-19 concerns, as well as increased regulation on Chinese tech and finance companies. Chinese leaders are willing to sacrifice short-term growth for more sustainable long-term growth.

The Chinese government is seeking to control all large data sets. One repercussion of this policy will be fewer listings of Chinese companies in US markets.

Several emerging market nations, such as Mexico and Brazil, have recently been forced to raise interest rates (to protect their currencies) due to inflation. At this same time, Chinese officials recently cut interest rates to stimulate the economy.

Fixed Income Takeaways:

Despite falling 10-year Treasury rates and corrections in certain commodities such as lumber and copper, investment-grade credit spreads have remained stable over the past few weeks. Stable credit spreads indicate that the recent “growth scare” may be temporary.

Fund flows continue to support spreads, with investment-grade (IG) and high-yield funds showing large inflows over the past week.

IG spreads widened two basis points (bps) yesterday to 85 basis points (bps). This 2 bps of widening was actually the most spread widening we’ve seen since March, highlighting the extremely strong environment for corporate credit.

The slope of the yield curve remains strongly positive, although it has flattened somewhat recently. A positively sloped yield curve is usually a good sign for future economic growth.

We continue to expect that the Federal Reserve (Fed) will provide further guidance on tapering at their Jackson Hole meeting in August. This week, the Fed’s June minutes were released and provided no further hawkish surprises.

The municipal bond market has been very quiet over the past few weeks. Supply is down, and many market participants are on vacation.

Despite quiet trading, money continues to pour into municipal bonds. Positive fund flows have shown in 59 out of the last 60 weeks, with over $2 billion flowing into municipals during the last week alone. For year-to-date (YTD) 2021, fund flows have been the highest on record.

Tuesday, 7/6/21

General Takeaways:

Broad US equities rose over 8% in the second quarter and have risen about 15.1% year-to-date (YTD). Global equities (ex-US) have risen about 7.8% YTD.

During the second quarter, US bonds (municipal and taxable) rose between 1-2%. On a YTD basis, municipal bonds have returned about 1%, while US taxable bonds have dropped about 1.7%.

Large cap growth stocks made a comeback during the second quarter, rising 11.9%, but small value stocks continue to lead YTD. On a YTD basis, small value stocks have risen 26.9%, while large growth stocks have risen 13%.

Are economic indicators peaking while inflation continues to expand? Purchasing Manager Index (PMI) data across the globe seems to be peaking, while inflationary pressures are showing no signs of abating. The Employment Cost Index (ECI), National Federation of Independent Businesses (NFIB) pay increases, and NFIB job openings data will all be important metrics of inflation to watch in July.

Apartment rents and house prices are both “sticky” forms of inflation. House prices are rising at a historically fast year/year pace (perhaps the fastest on record). Apartment rents have also begun to rise quickly after lagging home prices for some time.

The pace of fiscal stimulus has begun to slow. At the same time, consumers have started to draw down their savings. That said, the combined Federal Reserve and European Central Bank balance sheets have expanded by over $8 trillion over the past year, to $17+ trillion – the spigots of monetary stimulus remain wide open.

What could go wrong in the second half of the year?

  1. Delta COVID-19 variant spread and uneven vaccination uptake.
  2. Inflation pressures leading to margin pressures and lower corporate earnings.
  3. Economic growth & fiscal support peaking – transition to more sustainable growth is the likeliest outcome in our view.
  4. Policy error – either monetary, fiscal or regulatory.
  5. China slamming on the brakes on their economy / increased regulation.
  6. Sentiment/valuations and some feelings of complacency (additional details in the equity comments).
  7. Something else we don’t know.

Equity Takeaways:

Stocks were mixed in early trading on Tuesday. The S&P 500 fell about 0.5%, while small caps fell nearly 1%. The tech-heavy Nasdaq rose slightly.

The S&P 500 was up 14.3% (price only) through the end of June. Since 1950, every time the S&P 500 has been up greater than 12.5% in the first six months of the year, the average return going forward (16 times since 1950) has been over 7%, with a 12/16 positive hit rate.

Put another way, based on the first-half performance, history tells us that the market will likely continue rising as we move through 2021, but that gains are likely to be muted relative to the first half of the year. (Always keep in mind that past performance is not necessarily indicative of future results).

The market’s “summer swoon” typically begins in mid-July and runs through Labor Day. We have not seen any material pullbacks in the S&P 500 year-to-date. In 2021, we have only seen four pullbacks of greater than 3%. It would not surprise us to see a pullback during the summer swoon period, but we are not expecting a deep correction.

Equity fund flows remain robust, and valuations look expensive relative to history. Sentiment is stretched (most hedge fund exposure is in the 90th-100th percentile on gross and net long exposure). In short, market participants appear complacent.

Fixed Income Takeaways:

The 10-year Treasury yield hit 1.41% on Monday, its lowest level since early March. Low treasury yields continue to keep corporate funding costs down, leading to continued strong new issuance.

In the second quarter, investment-grade (IG) corporate bond spreads tightened 10 basis points (bps) to approximately 82 bps. Spreads are tight relative to history, and all-in yields corporate bond yields remain extremely low.

The spread between US investment-grade bonds and US high-yield bonds is currently about 182 basis points. This differential is presently at its lowest level since mid-2007.

The amount of cash in the banking system continues to balloon, which has kept a lid on money-market rates. Even out of 1-year, money market instruments are yielding less than 20 basis points.

This week, June Federal Reserve Open Market Committee (FOMC) minutes will be released.

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