As market rally matures, eyes remain on Fed

Thoughts

• Markets rallied to record highs Friday in reaction to the disappointing jobs report. Investors have returned to the “bad news is good news” mindset. The belief is that a more sluggish economic recovery will provide the Fed cover to remain stimulative for longer. The S&P 500® Index and Dow Jones Industrial Averages closed Friday at fresh record highs, though the NASDAQ lost last week as the shift from growth to value continues.
• As the trajectory of the market move has flattened, so has investor sentiment and flows. The CNN Fear & Greed Index hit 52 on Friday on a scale from 0-100, down from 80 in mid-April. Also, fixed income is attracting 32% of inflows over the past month, up from 7% in mid-March. The Federal Reserve released the semi-annual financial stability report, warning that asset prices are stretched and may be vulnerable to significant declines if risk appetites get dialed back, progress on the pandemic stalls or the recovery loses steam.
• Commodity prices continue to surge, with the Goldman Sachs Commodity Index gaining 28% this year on the outlook for an accelerating global economy and the government focus on infrastructure spending. The rally is broad-based, including lumber (+91%), lean hogs (+61%), gasoline (+53%) and copper (+39%). This is a major factor in the shift in inflation expectations and corporate commentary about supply chain pressure. On Monday, gasoline futures surged following a cyberattack that shut down pipelines running in 17 states.

News

• The monthly payroll report was the largest miss versus expectations since 1998, with the economy adding just 266,000 jobs versus the consensus estimate of nearly 1 million. The unemployment rate unexpectedly rose to 6.1% versus 6.0% in March and an estimate of 5.8%. There is a mismatch in supply and demand of labor, with a record level of job openings, while enhanced unemployment benefits, virtual schooling and health concerns are keeping workers at home. Some Republican-led states are pushing back against the enhanced unemployment payments, beginning with the removal of the $300 weekly federal supplement. Montana has gone as far as to provide a $1,200 bonus to return to work.
• Nearly 90% of companies have now reported, with a blended growth rate of 49% versus an expected 25% at the beginning of earnings season and 13% at the beginning of the year. Leading sectors include consumer discretionary (+201%) and financials (+141%) following a disastrous 1Q20. The percentage and magnitude of earnings beats are near record levels, though reactions to those beats are muted, reflecting the degree of optimism that had been priced into shares. Supply chain and cost pressures are a consistent theme on conference calls.
• President Biden will host a bipartisan group at the White House on Wednesday to work on an infrastructure deal. He reiterated his willingness to drop his corporate tax rate hike from 28% to 25%, likely acting as a 3% headwind to 2022 earnings. The bipartisan push is in reaction to worries that swing voter Senator Manchin would not support a partisan plan done through reconciliation, though the two sides remain substantially apart. The writing of the bills remains in the early phase, with progressive and moderate Democrats not yet aligned on the details.

What to Watch

• Inflation data will drive the headlines this week, with consumer price inflation on Wednesday and producer price inflation on Thursday. Other notable releases include NFIB Small Business and JOLTS job openings on Tuesday and retail sales, industrial production and consumer sentiment on Friday.