Markets pause as investors weigh the catalysts for the next move

Thoughts

• Equity markets have paused, with the S&P 500® Index fractionally lower in two of the past three weeks on Delta variant concerns and elevated valuations. Earnings season is largely over, and the FOMC meeting and GDP behind us, markets enter a difficult seasonal period with few catalysts to drive markets higher. The bond market continues to reflect peak growth and a potential Fed policy error, with the 10-year Treasury yield below 1.23% and the yield curve nearing the flattest level of the year despite the S&P 500 just 1% below a record high. Despite the stall, the trend for equities is strong, with gains in six-straight months and the buy-the-dip mentality still in place.
• Nearly 60% of the S&P 500 companies have now reported second-quarter earnings, with growth tracking towards 85%, compared with less than 60% expected at the beginning of earnings season. Revenues are also strong, up 20%. Forward estimates are trending higher, with 25% growth now expected in the third quarter and 21% for the fourth quarter, resulting in greater than 40% growth for the year. Estimates for 2022 are moving higher at a slower rate, and as a result, growth is now forecast at less than 10%. Continued upside to estimates is critical given that the S&P 500 trades at over 20x the current 2022 forecast.
• Market movers for August are going to be Covid-19 news and debt ceiling brinksmanship, both of which are likely to unsettle investors. In the face of these headwinds, expect equities to grow into their valuations over the next couple weeks.

News

• Real second-quarter GDP disappointed at 6.5%, though nominal growth (real growth plus inflation) above 13% reflects the strength of the economy. Consumer and capital spending contributed, while inventories and housing detracted. This week’s payroll report will be closely watched, as the labor shortage was a notable trend in earnings. More than 7.5 million are scheduled to lose the unemployment benefits after Labor Day and there is little indication that Congress plans to extend. The number of unemployed is nearly identical to the number of open jobs, though the skill mismatch has been a challenge. The ban on evictions expired over the weekend with 6.5 million households behind on payments by more than $20 billion.
• The bipartisan group of Senators finished text of their $1 trillion infrastructure plan that includes $550 billion in new spending. The goal is to send it to the House by the end of the week, though Speaker Pelosi has pledged that they will not pass it until the $3.5 trillion domestic spending plan is sent to the House. The infrastructure plan invests in roads and bridges ($110 billion), broadband ($65 billion), public transit ($39 billion), and other projects. It will be paid for with repurposed funds, changes to Medicare, and a mix of accounting measures. Lost in the spending conversation is the failure of Congress to raise or suspend the debt ceiling, forcing the Treasury to enact emergency cash-conservation steps that will buy Congress two to three months to act. The last major debt ceiling debate led to the downgrade of U.S. debt and a 20% correction in equities and a rally in bonds.
• The FOMC meeting was predictably uneventful, with no change in policy and no clarity on the timing of the taper. There was unanimous agreement that the economy continues to strengthen, though “substantial further progress” on inflation and employment is necessary before shifting policy. The Fed continues to believe that the period of elevated inflation is transitory. The lack of specifics on the taper in the press conference is shifting economists’ view of the timing of the announcement from the Jackson Hole Symposium in August to, perhaps, the September FOMC meeting. The Fed futures curve embedded a 74% chance of a hike in 2022 a month ago and 53% currently.

What to Watch

• Earnings season will continue this week, though the bulk of releases are behind us. Economic data include ISM manufacturing on Monday, durable goods on Tuesday, ISM non-manufacturing and composite on Wednesday, and the closely watched monthly payroll report on Friday.