Markets in holding pattern, awaiting next positive catalyst

Thoughts

• Equity markets continue in a saw-tooth pattern, with major indexes little changed since mid-April as a tug-of-war has developed between strong fundamentals and inflation concerns. Despite the directionless market, volatility is notably higher over the past 10 days, reflecting the nervous energy of investors. Improving earnings expectations and the flat market has dropped the P/E for the S&P 500® Index from 23x to 21x, though it remains elevated historically. Markets are likely to continue in a sideways pattern until we grow into our valuation.
• Investor sentiment went from extreme highs in mid-April to below-average currently despite the S&P 500 being less than 1% below a record. Quick shifts in emotions often occur in periods of directionless volatility, leading to an itchy trigger finger for investors. The Investors Intelligence poll showing bulls at 54.5% from 58.6% last week and the peak in mid-April at 63.7% with over 28% now expecting a correction. A positive catalyst is likely needed to reverse the trend in sentiment, though a large fiscal program is proving difficult, the likely next move by the Fed is to tighten policy, and the fundamental and earnings picture is already running at top speed.

News

• Global economic data continues to surge, with the global composite PMI at the highest level in 11 years. The U.S. reading of 68.1 was well above expectations and the highest reading on record. Eurozone composite PMI of 56.9 is the fastest rate in over three years with demand at the best level in 15 years. The vaccine rollout and subsequent reopening of the economy have the services sector outpacing manufacturing for the first time in eight months. Mobility data continues to reflect the gradual reopening of the economy, with mobility data time outside the home now just 5% below the pre-pandemic threshold, up from -16% at the beginning of the year. Restaurant traffic is down 6% from last February, compared with -25% in January. Travel to the workplace is stubbornly low, down 24% from before the outbreak, roughly equal to where it has been since last fall. The NY Fed’s weekly economic index continues to show explosive growth, indicating the pace of the economy at 11% in the most recent reading.
• Investors are speculating on the timing of a shift in Fed policy despite assurances from Fed officials that there will be no change in the near term. The minutes from April’s FOMC meeting continued to stress that the economy is far from meeting the Fed’s goals, though there was a discussion around when tapering should take place. The Fed continues to stress that the increase is transitory, but investors are more skeptical, with the curve now pricing in 100% chance of a rate hike by the end of 2022 despite Fed guidance that it won’t happen until 2024. Historically, the market tends to overprice rate hikes early in the economic cycle and neither the dot-plot nor the Fed Funds futures curve has a stellar track record in forecasting the path of Fed policy beyond the next several months but does reflect current thinking.
• The divide between Democrat and Republican infrastructure plans appears too wide to close, making a bipartisan plan unlikely following recent optimism. The Biden administration trimmed its ask to $1.7 trillion from $2.3 trillion but rejected the Republican counterproposal of $568 billion. The two sides remain far apart on the size, scope, and funding of the deal. The White House remains committed to increasing the corporate tax rate which is a nonstarter for Republicans. The infrastructure plan was an opportunity for a bipartisan plan before moving on to the $1.8 billion domestic spending package that is unlikely to garner any Republican support.

What to Watch

• A busy week of economic data awaits, highlighted by consumer confidence and new home sales on Tuesday, durable goods, pending home sales and revised first-quarter GDP on Thursday, and PCE deflator, personal spending and income, and consumer sentiment on Friday.