Markets continued their impressive and consistent rally, with the S&P 500® Index gaining in seven consecutive sessions and 16 of the past 18, hitting 10 record highs. The Index saw its fifth straight week of gains, with the last four more than 1%. Driving the momentum is aggressive retail investor activity, accelerating stock repurchases and strong seasonality. As earnings season winds down, investor attention will focus on a fresh set of catalysts, including the passage of fiscal spending deals, accelerating economic activity and improved investor sentiment. Small caps have led in recent weeks, with the Russell 2000 Index up 9% over the past month.
Bond market activity shows more skeptical investor attitudes than the equity market, with the 10-year Treasury yield below 1.50%, and the curve in a “bear flattening,” with short rates rising and long rates falling. The FOMC announced the tapering of asset purchases following Wednesday’s meeting, beginning in November, and ending in mid-2022. Chair Powell was clear that tapering does not lead immediately to tightening, as “there is still ground to cover to reach maximum unemployment” and “the inflation that we’re seeing is really not due to a tight labor market.” The Fed Futures curve continues to reflect a more aggressive tightening schedule than the Fed suggests, with a 70% chance of two-or-more hikes next year, up from a 30% chance a month ago.
Investors today have to choose which of two camps they fall into: the enthusiastic equity market investor or the skeptical bond market investor. Their view of the world and interpretation of data is increasingly divergent and incompatible.
There are signs of the economy regaining momentum, as the COVID-19 cases drop and restrictions ease. The U.S. is expected to lift a travel ban for more than 30 countries, accelerating reopening momentum. There are also initial signs of some of the supply chain pressures easing, with shipping rates moderating, auto sales accelerating and the chip shortage improving. Commodity prices have declined for three consecutive weeks. October payrolls were a better-than-expected 531k, above the estimate of 413k and September’s 312k, driving the unemployment rate to 4.6%, the lowest level since last March. Wage growth was an impressive 4.9% from a year ago, which is good for workers, but another sign of inflation. Availability of workers remains a concern, with the labor force participation (61.6%) still 1.7% below pre-pandemic levels, with 4.2 million fewer people employed. Worker productivity is an issue, with productivity is running at a 40-year low, and unit labor costs (compensation per unit of output) at an annualized rate of 8.3% in the third quarter.
The $1 trillion infrastructure bill passed the House on Friday, with President Biden set to sign it into law. The bill includes $550 billion in new spending on roads, bridges, utilities, broadband and green initiatives. The immediate impact to earnings is expected to be modest and the impact on inflation limited given the gradual acceleration in earnings. Buried in the negotiations that resulted in the passage was a commitment to pass the Build Back Better spending deal by next week and a commitment from moderate Democrats to support the legislation pending a score by the Congressional Budget Office.
Third-quarter earnings season is nearly complete with 90% of companies reported, and the S&P 500 saw its sixth-straight quarter with growth more than 10% better than originally estimated. Earnings growth was 42% led by energy, materials, and industrials. Revenue growth of 16% was the second highest since 2008. Estimates for forward quarters shows deceleration, with 21% growth expected in the fourth quarter, with little adjustment in the estimate since July. Analysts are concerned that margins have peaked given the pressure on input costs, with the net margin in the third quarter of 12.9% above the five-year average of 10.9%, but modestly below the second quarter at 13.1%. Continued positive estimate revisions are important, given that the S&P 500 currently trades at 21.4x, well above the long-term average of 16.5x.
What to Watch
Inflation data will be closely watched this week, with producer price inflation reported on Tuesday and consumer price inflation on Wednesday. Other notable releases include NFIB Small Business on Tuesday, and consumer sentiment and JOLTS job openings on Friday. Thursday is Veterans Day, so there are no releases.
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