Markets grind higher despite signs of global slowdown

Thoughts

• Equity markets continue to grind higher, with weekly gains in six of the last eight weeks despite troubling headlines. The gains in recent weeks have been indiscriminate, with similar gains in growth versus value, large versus small and domestic versus international. The S&P 500® Index has already seen 48 record closes in 2021, the second-highest number at this point in the year in the history of the S&P 500, bettered only by 1964. The S&P 500 has returned 20% so far this year, eclipsing the most optimistic forecasts by Wall Street analysts from the beginning of the year, driving price targets higher.
• Investor sentiment metrics suggest the average investor remains uncertain, with the CNN Fear & Greed Index at 44 on a scale from 0-100. Professional investors, however, are as bullish as they have been in decades, with the percentage of “buy” ratings of stocks at the highest level since 2002. The average price target of those analysts suggests 10% upside to the S&P 500. This exuberance is seen by many as a sign of excess, mirrored by the fact that the S&P 500 has not seen a 5% pullback in nearly 200 days, double the long-term average.
• Markets continue to defy the sobering headlines, as lack of attractive alternatives to invest drive incremental dollars to equity markets.

News

• China shuttered a port responsible for 25% of container traffic this week after the discovery of a coronavirus infection, creating a backlog of 40 container ships. Many ships are being rerouted to Shanghai, causing worsening congestion and threatening to further boost container rates that recently spiked to $20,000 for a 40-foot box for Shanghai to Los Angeles. This is double the rate from two weeks ago and compares with under $2,000 before the pandemic. Supply chains are already strained following a typhoon at a port in Yantian last month and reverberations from the Suez Canal blockage in March. This could maintain cost pressures and potentially lead to product shortages. Recent economic data in China, including industrial production, retail sales and fixed asset investment reflect a meaningful slowdown in economic activity.
• Recent comments from Fed officials suggest a tapering announcement is likely at the September FOMC meeting. Five Fed governors and presidents explicitly backed the idea in speeches last week, though a weak jobs report in early September due to the delta variant could push the announcement back to November. Inflation data last week provided a mixed picture, with CPI and PPI still at elevated levels, but there are signs of a peak in cost pressures. To date, Chair Powell has avoided a repeat of the 2013 taper tantrum, with consistent talk of a tapering not driving interest rates higher, with the 10-year Treasury yield under 1.30%.
• Companies are content with holding “dry powder” given the degree of uncertainty facing managements, with cash and short-term investments on corporate balance sheets at a record $6.8 trillion, 45% higher than the five-year average. Strong earnings paired with elevated caution is driving the cash conservation effort, and it is likely to result in elevated merger and acquisition activity going forward. The second quarter saw a 12% jump in M&A activity from a year ago, thought the pace remains below the pre-pandemic level.

What to Watch

• A light week of data awaits, with retail sales and industrial production on Tuesday, housing starts on Wednesday, and leading indicators on Friday. The minutes from the July FOMC meeting will be released on Wednesday.