Small Cap Labor Day Rally Getting Underway In the below chart, daily data since July 1, 1979 through August 20, 2021 for the Russell 2000 index of smaller companies are divided by the Russell 1000 index of largest companies, and then compressed into a single year to show an idealized yearly pattern. When the graph is descending, large-cap companies are outperforming small-cap companies; when the graph is rising, smaller companies are moving up faster than their larger brethren. The most prominent period of outperformance generally begins in mid-December and lasts until late-February or early March with a surge in January. This period of outperformance by small-caps is known as the “January Effect” in the annual Stock Trader’s Almanac. In recent years, another sizable move is quite evident just before Labor Day. One possible explanation for this move is individual investors begin to return to work after summertime vacations and are searching for “bargain” stocks. In a typical year, small-caps would have been lagging and could represent an opportunity relative to other large-cap possibilities. As of today’s close, Russell 2000 is up 13.4% compared to the Russell 1000 being up 19.0% year-to-date. Lagging small-caps and resilient U.S. consumers could be the ideal setup for a repeat of this pattern this year. However, the small-cap advantage does historically wane around mid-September.
Small-Caps Bounce Fri, Aug 27, 2021 ln today's Morning Lineup, we noted the inverse correlation between performance this week and market caps. As shown in the major US Indices screen of our Trend Analyzer tool, the two best performers over the past five days have been Micro-Caps (IWC) followed by small caps like the Russell 2000 (IWM) and the Core S&P Small-Cap ETF (IJR). Mid-cap ETFs are the next best performers with high 2% gains then most large cap indices have only risen around 1.5% this week with the exception of the Dow (DIA) which has not even gained 1%. As for where these indices are trading relative to each one's trading range, it is partially a mean reversion story. Small caps were deeply oversold one week ago and are now sitting just below their 50-DMAs. While not to as extreme of a degree, mid-caps were similarly trading a full standard deviation below their 50-DMAs last week. Today, they are on the opposite side of their 50-DMAs and on the verge of overbought readings. As previously mentioned, small caps like the Micro-Cap ETF (IWC) and Russell 2000 ETF (IWM) were oversold last week. From a charting perspective, each of these indices' rallies this week are not only bounces from extreme oversold levels, but they also follow brief dips below their 200-DMAs. But whereas the past five days have seen solid gains, yesterday saw IWC and IWM reject their 50-DMAs and the high end of their ranges that have been in place since late July. In other words, even though small caps have led the market this week, they are not out of the woods yet. Looking at the relative strength lines of small caps like IWC and IWM versus the large cap S&P 500 (SPY) over the past year, the past week's outperformance again is a blip on the radar and has only put a small dent in the longer term trend of underperformance. Where that is not necessarily the case is small market caps versus the smallest market caps. As shown below, the relative strength line of the Micro-Cap ETF (IWC) versus the Russell 2000 (IWM) broke out of the past few months' downtrend over the past few days.
So, absent a total and monumental collapse of the market today and tomorrow to close out the month, it's looking like the SPX will finish the month higher once again here, and make it 7 months in a row that it has finished the month in the green. Historically when such occurence has happened, the next 6 months has seen the SPX higher 13 out of 14 times, with a pretty healthy +7.9% average return. Feels like this all sound like a broken record (or at least has for the past 16 months now), but looks like absent any totally out of left field surprises (black swan events) would signal continued strength from here.
September’s First Trading Day Bullishness Waning Although the first trading day of September has been up in 15 of the last 26 years, this trend appears to be fading as the S&P 500 has been down nine of the last thirteen first trading days. DJIA’s first trading day performance has experienced a similar diminishing trend, down eight of the last thirteen. NASDAQ has been modestly stronger recently, but is still mixed, up seven and down six. Proximity to the three-day Labor Day holiday weekend can dampen trading activity, but this will likely not be much of a factor this year with the first falling on Wednesday, well before the holiday.
Emerging Markets Leave China Behind Tue, Aug 31, 2021 In last night's Closer, we noted the record underperformance of Chinese equities relative to the US over the past six months. As a result of the weakness in Chinese equities, the MSCI Emerging Market ETF (EEM)—which has roughly a 37% weight in Hong Kong and Chinese stocks—is well off of its highs and has been trending lower over the past several months. Today, EEM is up a healthy 1.37%, but that brings it just short of its 50-DMA which recently fell below its 200-DMA. That is also at similar levels to the lower high from the start of this month. When factoring out China, emerging markets look much better. Again, the MSCI Emerging Market ETF that excludes China (EMXC) is currently 1.13% below its 52-week high, but the downtrend that has been in place since the early June highs has been on the ropes over the past couple of sessions. Yesterday saw the ETF trade and close right at that downtrend line, but the 1.15% gain today has smashed through it. That leaves EMXC at the highest level since June 15th. The ETF is also at some of the most overbought levels (1.8 standard deviations from its 50-DMA) since then. Pivoting over to bonds, looking at the Fixed Income screen of our Trend Analyzer, the best performer over the past five days is also in the EM space. The USD Emerging Markets Bond ETF (EMB) had been mostly flat throughout the summer trending right alongside its sideways 50- and 200-DMAs. Significant gains last Friday and yesterday led EMB to break out of that range as it reaches some of the highest levels since February today. As previously mentioned, EMB has not ventured far from its 50-DMA recently. In fact, the rolling 50-day standard deviation has been right around some of the lowest levels on record since EMB began trading in 2008. Given that lack of volatility, the rip higher this week has resulted in the ETF moving well beyond the upper end of its narrow trading range. In fact, yesterday the ETF closed over 3 standard deviations above its 50-DMA. That joins only 14 other days where the ETF closed at least 3 standard deviations above its 50-DMA with the most recent of those back in June 2019 when it reached as high as 4 standard deviations above its moving average.
End of Pandemic Programs Loom Thu, Sep 2, 2021 Ahead of tomorrow's nonfarm payrolls report, this week's initial jobless claims release came in at 340K; 5K below expectations. That was a 14K decrease from last week's level which was revised higher by 1K. Additionally, this week's decline entirely erased the move higher last week. With yet another drop in jobless claims, the indicator has made another pandemic low and is within 84K of the last sub-1 million print (256K on March 13, 2020) prior to the parabolic spike last spring. As for on an unadjusted basis, claims fell further below 300K to 287.8K this week. This time of year typically sees seasonal tailwinds for claims, but this week did mark the sixth consecutive decline. That made for another pandemic low as claims by this measure are just 35.9K away from the March 2020 levels. Granted, the seasonal strength from the past few weeks is likely to wane until the end of the year. As shown in the second chart below, September (approximately week numbers 37 through 40) historically marks the time of year that week over week increases in the unadjusted number become more frequent, and as a result, claims begin to consistently tick higher. While seasonal headwinds are on the way for regular state claims, overall claim counts will begin to see drops due to the expiration of pandemic era programs. This includes the additional $300 per week payments and programs like PUA and PEUC. In the most recent week, PUA claims came in above 100K for a fourth week in a row. As for continuing claims, the headline number for regular state programs remains strong with claims hitting another pandemic low of 2.748 million, down from 2.908 million last week. That 160K decline was the largest since a 316K decline in the second to last week of July. Factoring in all programs adds an additional lag to the data meaning the most recent reading is through the week of August 13th. In that week, total claims rose to 12.2 million from 12.02 million in the prior week. In spite of only having a couple of weeks until the end of the programs, that increase was driven by PUA claims which rose by over 400K and marked the largest one-week increase for the program since April 23rd (420.6K). That brings the total count of pandemic era programs (PUA and PEUC claims) a couple of weeks before their expiration to 9.2 million. As for the other programs, regular state claims and PEUC claims were little changed at 1.6K higher and 6.04K higher, respectively. Meanwhile, the extended benefits programs saw a significant decline of 237.07K down to 114.4K, although, that program has been particularly volatile over the past several weeks, so we would caution again reading too deep into that move.
Bullish Sentiment Finally Rises in Back to Back Weeks Thu, Sep 2, 2021 The S&P 500 has continued to press higher resulting in a coincident rise in sentiment. The AAII's weekly reading on bullish sentiment rose back above 40% for the first time since the week of July 8th. While 43.4% is not a particularly elevated reading on sentiment (72nd percentile of all periods), the move higher is particularly notable in that it was the first time bullish sentiment has risen in back-to-back weeks since February. That is especially surprising given the fact that bullish sentiment was very elevated at points between now and then, such as back in the spring when it eclipsed 50%. That is also a historically long stretch of time without back-to-back increases in bullish sentiment. As shown in the second chart below, at just over half of a year-long, the only two similar streaks on record were in 1995 and from 1997 to 1998. Negative sentiment has broadly picked up over the past couple of months. In the AAII survey, bearish sentiment was slightly higher at 33.3% versus 33% last week. While below the peak from only a couple of weeks ago, that is still elevated versus readings from earlier this year. Similarly, the Investors Intelligence survey of newsletter writers has also seen bearish sentiment on the rise throughout the summer. This week, it topped 20% for the first time since March 10th. At 21.3%, bearish sentiment in this survey is at the highest level since last October. With that said, the current reading is also well below the 20 year average of 24.19%. As a result of the larger gains to bullish versus bearish sentiment, optimism remains the favored response in the AAII survey. The bull-bear spread rose back into positive double digits this week for the first time since the last week of July. Given both bullish and bearish sentiments were higher, neutral sentiment has continued to unwind. That reading fell 4.3 percentage points this week to a new low of 23.2%. That was the fourth decline in the past five weeks as neutral sentiment came in at the lowest level since mid-April.
August Payrolls Disappoint Friday, September 3, 2021 It seems to be two steps forward, one step back for the U.S. labor market. The U.S. Bureau of Labor Statistics released its August employment report this morning, revealing that the domestic economy added a disappointing 235,000 jobs during the month, falling well short of Bloomberg-surveyed economists’ median forecast for a gain of 733,000. This comes on the heels of a strong July during which payrolls climbed by an upwardly revised 1.053 million jobs. The unemployment rate fell to 5.2% in August, in line with expectations, and was paired with an unchanged labor force participation rate, which stayed at 61.7%. “The Delta variant surge is the unsurprising story behind August’s big payroll miss,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Leisure and hospitality jobs, a proxy for economic reopening, were flat month over month. The good news is that we see promising signs Delta’s effect will wane in coming months and payrolls will resume growing at a fast clip.” As seen in the LPL Chart of the Day, we remain 5.3 million payrolls shy of February 2020’s peak. The other key takeaway from this report is wage pressures are building. Average hourly earnings came in hotter than expected, an increasingly common occurrence, posting a 0.6% month-over-month gain versus expectations for 0.3%, and a 4.3% gain year over year versus expectations for 3.9%. Wages have important implications in the inflation debate, as they and rents are considered to be among the “stickier” components of inflation. Today’s report is likely to bolster those in the camp asserting inflation will be less transitory than the Federal Reserve (Fed) thinks, though it should be noted that the lack of employment growth in lower wage in-person sectors likely contributed to the higher wage numbers. Looking ahead, we continue to believe there is reason to expect a strong jobs rebound in coming months. Schools closed for the summer, potential disincentives from enhanced unemployment benefits, and the troublesome Delta variant have all acted as speed limits on the pace of employment growth recently. August’s report, though, figures to be the last where all of these factors remain in full force. Enhanced unemployment benefits are set to expire on Labor Day (ironically), meaning their effects will only be present for part of the September report’s observation window, and will be fully gone by the October report. Schools and daycare facilities, meanwhile, are beginning to reopen, freeing up parents to rejoin the labor force. And, most importantly, we are seeing promising signs that the worst of the latest flare-up in COVID-19 cases may be behind us. Zooming out, this job report has the potential to delay the Fed’s tapering timeline. Fed Chair Powell has made it clear that the labor market will serve as his tell regarding when to begin tapering asset purchases. With today’s big payroll miss, it is clear the labor market is under some near term pressure, and while these pressures are likely to dissipate the Fed will probably err on the side of caution to avoid acting prematurely. The next month is sure to be an interesting one for Fed-watchers.
Global Monetary Policy and What Likely Comes Next Tuesday, September 7, 2021 The Covid-19 pandemic was an unprecedented shock to a large majority of global economies. But the economic damage was met with an extraordinary global monetary response with the Federal Reserve (Fed), European Central Bank (ECB), the Bank of Japan (BOJ) and the Bank of England (BOE) all providing emergency levels of monetary accommodation. As seen in the LPL Research Chart of the Day, central bank balance sheets have grown by $10 trillion since the start of the pandemic and are currently at $25 trillion for the Fed, BOJ, ECB and the BOE, combined. While we are hopefully past the peak of the pandemic, monetary accommodation continues largely unabated. However, there will likely be a reduction of monetary support in the coming years as global economies continue to recover. Following is what is currently ongoing from major central banks and what the next steps are likely to be for the Fed, ECB, BOJ and BOE. Current monetary policy remains very accommodative The Fed is currently purchasing $120 billion a month of Treasury and Agency mortgage-backed securities (MBS). Since early 2020, these purchases have grown the balance sheet by more than 80%. The ECB is currently buying bonds under its €85 trillion Pandemic Emergency Purchase Program (PEPP) and approximately €20 billion a month through its Asset Purchase Plan (started in 2014). Both QE programs have increased the size of the balance sheet by 80% since the beginning of the pandemic. The BOJ increased its Japanese government bond (JGB) purchases to an ¥80 trillion annual pace and increased purchases of commercial paper, corporate bonds, and exchange-traded funds. Together with the bank’s increased lending facilities, the new asset purchases have increased the size of the balance sheet by roughly 25% since the beginning of the pandemic. The BOE put in place a £875 billion program to support the UK economy and financial market functioning. The bank’s asset purchases have increased the size of the balance sheet by more than 90% since the beginning of the pandemic. “Monetary support has helped limit the economic damage from the pandemic but now may be the time to start removing some of those emergency levels of support,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “However, gently taking your foot off the accelerator is different from applying the brakes. We still expect monetary policy to be supportive for the foreseeable future.” What is likely to happen next? The Fed will likely start to taper its bond purchases either late 2021 or early 2022 with interest rate hikes penciled in for some time in 2023. The details of the taper are not known at this point but we would expect a prorated reduction in Treasury and MBS over a 6-9 month window. We’re likely to get additional details after the next meeting on September 21 and 22. For the ECB, PEPP is due to run until at least the end of March 2022. Inflation readings have come in hotter than expected in the Eurozone so the hawks are talking about the need to taper bond purchases sooner rather than later. We will likely get more details following the ECB meeting on September 9. Sustained inflation readings at or above target have been, and remain, a challenge for the BOJ. The bank doesn’t expect inflation to reach its 2% target until 2024, at the earliest. As such, easy monetary policy is likely to remain after the other advanced economies start to reverse course. The next BOJ decision occurs on September 22. The BOE has recently stated that “some modest tightening of monetary policy is likely to be necessary” over the next two years to keep inflation under control. As such, the BOE is expected to start to increase interest rates next year and is on pace to normalize monetary policy before the Fed and the ECB. More details are likely to come after the conclusion of the September 23 meeting. As the global economic recovery continues, current levels of emergency monetary accommodation are no longer necessary, in our view, and we are likely to see central banks start to adjust policy. To be clear though, the reduction in these emergency level policies should not be construed as tightening. While we expect the eventual reduction in asset purchases from most central banks to happen soon, interest rate hikes, especially in the U.S., are still several years away, in our opinion. Monetary policy is likely to remain accommodative for the foreseeable future.
What Could Happen The Rest of the Year to Stocks and Bonds? Wednesday, September 8, 2021 This week in the latest LPL Market Signals podcast, Ryan Detrick and Lawrence Gillum discussed global central bank policy, recently weakening economic data, and where stocks and bonds could go the remainder of this year. In today’s blog we will focus on their discussion on stocks and bonds. The S&P 500 Index was up more than 20% by the end of August for the first time since 1997 and it has made a new high every single month this year so far (9 for 9). Incredibly, it made 53 new highs before August was over, the most ever. Any way you slice it, this year is historic for the bulls. The catch (and there’s always a catch) is the S&P 500 hasn’t pulled back 5% all year, with the last 5% pullback last October. Not to mention September is the worst month for stocks the past 10 years, 20 years, and since 1950. But history says that great starts to a year tend to see continued strength the final four months. “Looking at the previous top 10 starts to a year ever, the final four months have gained eight times,” explained LPL Financial Chief Market Strategist Ryan Detrick. “So should we see any seasonal weakness, we’d use it as an opportunity to buy before likely continued strength.” As shown in the LPL Chart of the Day, 2021 ranks as the 6th best start to a year ever. The previous top 10 best starts to a year averaged a return of 4.0% the rest of the year, with a very solid median return 5.4%. Turning to bonds, we continue to expect higher yields due to the growth and inflation outlook, with a target of 1.75% on the 10-year treasury yield by year end. This of course could pressure bonds, as they trade inversely with yields. From a portfolio point of view, we would keep overall interest rate sensitivity muted and favor mortgage-backed securities and short- to intermediate-maturity investment grade corporates. As a result of our higher rates call, we suggest being underweight longer maturity high grade corporates or long-term treasuries, which are more sensitive to rising rates. So sum it up, taking a more of a defensive posture as it relates to interest rate sensitivity makes a lot of sense the remainder of 2021. Also, the potential this week for a European Central Bank (ECB) announcement on tapering could push European yields higher, which in turn could push U.S. yields higher as well.
Ida Impacts Claims Thu, Sep 9, 2021 Last week's initial jobless claims number was revised higher by 5K to 345K. Partially thanks to that upwards revision and a big drop this week, claims fell by 35K for the biggest one-week decline since the last week of June. That sizeable decline brings initial claims to the lowest level of the pandemic at 310K on a seasonally adjusted basis. On a non-seasonally adjusted basis, claims are actually below 300K as has been the case for the past three weeks now. This week marked the seventh in a row that unadjusted regular state claims have fallen week over week making for the longest stretch of consecutive declines in the number since a 13-week long run ending in the first week of July last year. Factoring in Pandemic Unemployment Assistance (PUA), claims totaled a pandemic low of 380.5K thanks to a drop back below 100K by the PUA program. With that said, the program is also nearing its end. Lagged an additional week to the initial claims number, continuing claims also set a new low this week. Through the final week of August, continuing claims dropped for a second week in a row to 2.783 million (2.74 million expected) from 2.8 million the prior week. That reading is roughly 1 million above the pre-pandemic reading (1.784 million on March 13, 2020. There is yet another week of lag to the data when all programs are included. Factoring in all auxiliary programs, the most recent data is through the week of August 20th. Total claims for that week were still above the low of 11.8 million from the last week of July, but they did cross back below 12 million. The biggest contributors to that decline were PUA claims which fell by 322.7K to 5.051 million and regular state claims which fell by 135K. Other programs, namely extended benefits, weighed on claim counts. The extended benefits program has been notably volatile over the past few months now, and that continued in the most recent week of data. The program rose from a near pandemic low of 114.4K to 311.3K which is at the upper end of the past several months' range. One other interesting point to note on this week's claims data was the impact of Hurricane Ida. Regular state claims fell by 8K nationally on a non-seasonally adjusted basis this week, and that count would have been much better without the epicenter of recent hurricane news: Louisiana. With the state still recovering from the storm, claims more than quadrupled this week. In fact, the increase was even larger than that of the most populous state, California, which saw claims rise by 5.6K.
Strong Start to September Manufacturing Data Wed, Sep 15, 2021 Last month saw a broad pivot lower across the regional Federal Reserve Bank manufacturing surveys. With the release of the Empire Fed's survey this morning, we now have the first reading for the month of September. Rather than the more dour results of August, today's results showed a broad acceleration in activity across categories in the New York region. The headline index was expected to show an ever so modest decline to 18.0 from 18.3 last month. Instead, it popped 16 points to 34.3 which is actually the seventh-highest level on record. Just about everything drove the uptick in the headline number as only one index for current conditions was lower on a month-over-month basis: Prices Paid. Not only did almost every category show acceleration, but current levels across the board are in the top decile of historical readings. While elevated and higher readings are perhaps not positives, Delivery Times and Prices Received both came in at record highs. Some of the categories to have seen the most notable upticks this month were related to demand. Both New Orders and Shipments saw increases in the top few percentiles of their respective historical ranges. In fact, New Orders surpassed the July high to reach the highest level since July 2004. The reading on Shipments has been particularly volatile over the past few months, and the September reading was still below the high from July. That being said, it still came in at a very healthy level in the 90th percentile versus the 21st percentile reading in August. Additionally, expectations were far stronger. Coming in at 54.7, that index was at a seventeen-year high. One area that expectations have gone the other way of current conditions is unfilled orders. While the growth in demand meant the current conditions index is right below the spring highs, six-month expectations came in at zero for the second month in a row. In other words, reporting businesses expect backlogs to remain at current levels six months out even as inventories are being built up at one of the fastest clips on record. For the past few months, the index for Delivery Times had been showing some relief, but over the past two months, there has been increasing evidence once again of worsening supply chains. The past two months have both seen the index increase over 8 points which brings it to yet another record high of 36.5. While time will tell if the prediction is right, on the bright side, expectations are much more modest for future delivery times. Prices are a somewhat similar story. Current levels are unlike anything seen through the history of the survey, but Prices Paid have now fallen for four months in a row. That lower does not mean prices are falling but are instead growing at a slower rate. As such, price increases are continuing to be passed on to customers as prices received increased for the third month in a row to a new record high of 47.8. Employment-related indices also had a strong showing this month. The region's businesses continued to take on more workers with the index rising to 20.5 which is just below the pandemic high of 20.6 set back in June. Granted, there are also signs that demand for labor is not being met. In spite of that uptick in employment, the average workweek surged. That index leaped 15.4 points to come in at the second-highest level on record. Perhaps because the demand for labor cannot be filled, responding firms appear to be turning to the other side of the production function. Readings on plans for Capital Expenditure and Technology Spending also shot higher this month with the latter rising to record levels. In fact, the month-over-month increase in Technology Spending was the second-largest monthly gain on record behind a 19.1 point leap in April 2009.
Mid-Pack Performance for Post-Election Year Octobers October often evokes fear on Wall Street as memories are stirred of crashes in 1929, 1987, the 554-point drop on October 27, 1997, back-to-back massacres in 1978 and 1979, Friday the 13th in 1989 and the 733-point drop on October 15, 2008. During the week ending October 10, 2008, Dow lost 1,874.19 points (18.2%), the worst weekly decline in our database going back to 1901, in percentage terms. March 2020 now holds the dubious honor of producing the worst, second and third worst DJIA weekly point declines. The term “Octoberphobia” has been used to describe the phenomenon of major market drops occurring during the month. Market calamities can become a self-fulfilling prophecy, so stay on the lookout and don’t get whipsawed if it happens. Post-election year October’s are neither great nor bad since 1953, ranking mid-pack across DJIA, S&P 500, NASDAQ and Russell 1000 with gains averaging from 0.9% (DJIA & Russell 1000) to 1.4% (NASDAQ). DJIA has the best historical odds for gains having advanced in 12 of the last 17 post-election year Octobers. Despite the best average gain, NASDAQ actually has the worst record, declining in 6 of the last 12 post-election year Octobers. A 12.8% gain in 2001 boosts its average. Should a meaningful decline materialize in October it is likely to be an excellent buying opportunity, especially for any depressed technology and small-cap shares.
Inflation Shows Signs Of Moderating Economic Blog Tuesday, September 14, 2021 After a crazy summer of nosebleed inflation readings, we may finally be starting to see signs of transitory inflation. The Bureau of Labor Statistics released the August Consumer Price Index (CPI) data this morning, which came in softer than expected. Headline CPI climbed 0.3% month-over-month vs. estimates of 0.4%, while core CPI jumped only 0.1% month-over-month vs. estimates of 0.3%. Base effects from rolling off weak numbers a year earlier meant the year-over-year numbers were larger, but we find more usefulness in the monthly numbers until we get past the weak comparisons versus a year ago. To be sure, a resurgent Delta variant played a part in dampening overall inflation, and future reports will help clarify the magnitude of its effect—but, expectations were already lowered to account for this dynamic and the data still missed. One major takeaway from the report is that the composition of the decline suggests that the long-awaited abatement in price spikes in supply-constrained segments of the economy could be upon us. These relatively smaller parts of the overall CPI basket were driving an outsized portion of the gains this summer. Used cars and trucks (-1.5%), airfare (-9.1%), and lodging away from home (-3.3%) all declined significantly month-over-month. “’Transitory’ has certainly been lasting longer than we originally thought it would,” said LPL Financial Chief Market Strategist Ryan Detrick. “But the CPI components that displayed summer volatility resulting from supply chain bottlenecks are beginning to resolve themselves as expected.” As seen in the LPL Chart of the Day, used car and truck prices have experienced a drop-off after the summer surge, which saw them become the posterchild for bottleneck-driven inflation from semiconductor shortages. As we have highlighted in previous inflation blogs, we make special note of the trend in rents since they are viewed as “stickier” parts of the inflation outlook and count for more than 40% of the overall calculation. Moreover, the Delta variant likely has less of a direct effect on rents compared to some of the other components mentioned earlier. As such, owners’ equivalent rent of primary residences rose 0.25% month-over-month, down slightly compared to the prior two months, a modest pace that is unlikely to spook even the most hawkish inflation watchers. Gauging the Federal Reserve’s reaction function to inflation and jobs data is fast becoming the market’s primary focus. Following August’s weak payroll report, market participants have mostly pushed back their expected timelines for tapering asset purchases so long as inflation does not spiral out of control in the meantime. Judging by the early market reaction, today’s softer inflation numbers are confirming that narrative.
Retail Sales Surprise To The Upside Economic Blog Thursday, September 16, 2021 U.S. consumers shocked economists in August with their willingness to spend in the face of recent jitters over the economic outlook. This morning, the U.S. Census Bureau released August retail sales data showing overall retail sales grew 0.7% month-over-month vs. a consensus forecast for a 0.7% drop, while retail sales ex autos and gas rose 2% month-over-month vs. a consensus forecast for no change. Auto sales remained under pressure because of supply chain bottlenecks and higher prices, accounting for the large gulf in the numbers. The big beats come on the heels of disappointing July data, which received additional negative revisions, taking a small bit of the shine off August’s numbers. Nonetheless, the spending resilience shown in this report is receiving an overwhelmingly early positive response, as economic releases in recent weeks have generally been surprising to the downside. COVID-19’s resurgence in recent months is surely to blame for a significant portion of the lowered expectations, but consumers have also been forced to contend with rising prices, severe weather events, lukewarm payroll gains, and cuts to enhanced unemployment benefits. “There have been several reasons to question the consumer outlook recently,” explained LPL Financial Chief Market Strategist Ryan Detrick. “And yet, the old mantra ‘never bet against the U.S. consumer’ continues to ring true. This has been a volatile series of late, but we look for the consumer to continue powering this economy well into the future.” As seen in the LPL Chart of the Day, retail sales ticked significantly higher in August following a difficult July. The familiar theme of goods over services consumption seen during prior virus flare-ups is evident in this report, as well as a back-to-school boost. General merchandise stores (3.5%) and nonstore (online) retailers (5.3%) showed large monthly boosts, reversing a disappointing July. In addition, furniture and home furnishing stores rose nicely (3.7%). Meanwhile, food services and drinking places (0.0%), an in-person segment most impacted by virus caution, held steady against forecasts for a decline, while volatile electronics and appliance stores (-3.1%) showed weakness. We continue to believe that successfully tackling Delta could set up a fourth quarter growth rebound despite many strategists increasingly turning sour on the second half of the year. Cases from this latest COVID-19 wave are starting to decline, and plentiful job openings and impressive wage gains data should prevent a major income shortfall resulting from the expiration of enhanced unemployment benefits. Consumers also still have elevated excess savings relative to history—in the neighborhood of $2 trillion. We continue to look for a resilient consumer, as well as for services spending to play catch-up vs. goods spending in coming months.
Why Evergrande Isn’t The Next Lehman Friday, September 17, 2021 Chinese property developer Evergrande’s liquidity crisis has sparked fear and massive selling in Chinese property stocks over the past several weeks. The big question is could this be the first domino to fall, sparking a systemic risk scenario, similar to when Lehman Brothers went under 13 years ago this week? The good news is we don’t think so, but we’ll get to that later. With more than $300 billion in liabilities and only $15 billion in cash on hand, Evergrande is currently the world’s most indebted real estate developer. Worries are mounting that starting next week it won’t be able to pay $84 billion of interest due (according to Bloomberg), along with potentially missing a principal payment on at least one of its loans. With Evergrande’s share price down more than 80% this year, investors are clearly voting with their pocketbooks, while the chart below shows the pressure its dollar bonds have been under as well, at deeply distressed levels to the tune of 28 cents on the dollar recently. Multiple downgrades have happened the past two weeks, and some rating agencies are noting that an outright default is probable. Should this happen, what could the fallout be? With 1,300 real estate projects in 280 cities in China, could China’s communist government intervene to avoid a messy default? So far that answer has been a resounding no, with the company instead looking to banks and other creditors to help the impact of a default. The bad news keeps coming, as yesterday, Evergrande suspended trading of it’s onshore corporate bonds, after yet another downgrade, taking it one step closer to restructuring or default. So is Evergrande China’s version of Lehman Brothers? Here are three reasons we don’t think so. First, the dollar bonds will likely get restructured, but most of the debt is in global mutual funds, ETFs, and some Chinese companies and not banks or other important financial institutions. Remember, Lehman Brothers was held on nearly all other financial institution’s books, so not nearly as many institutions will be impacted by this versus Lehman. Secondly, we think the odds do favor the Chinese communist government will get involved should there be a default. They are holding out as of now, but the fallout could be too great for them to avoid intervening. Finally, Evergrande has tangible assets that can be sold off to settle financial obligations. Their assets aren’t great and creditors know that the company is in financial trouble , so the value of its assets aren’t likely worth as much as they think but it will still help settle some debts. Remember, Lehman didn’t have hard assets it could sell off whereas Evergrande does. “Although the impact from Evergrande’s liquidity crisis is enormous, the good news is the fallout hasn’t started to spillover to other markets,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Short-term funding markets are acting just fine in China thus far; remember, it was the money markets in the U.S. that first started to show cracks in the system in early 2008, well before the wheels fell off.” As shown in the LPL Chart of the Day, China’s money markets aren’t showing any signs of systemic risk. These tend to be the canary in the coal mine, and the fallout appears to be fairly contained as of now. LPL Research downgraded our view on emerging markets to negative from neutral last month, due to concerns over China’s regulatory crackdowns and heightened political risk. Now with Evergrande’s liquidity crisis in the mix, we continue to recommend an underweight to emerging markets in portfolios. This is a very fluid situation and one that could clearly change on a dime. Although the Chinese communist government has avoided helping Evergrande so far, we think the odds do favor some type of eventual bailout to limit the ripple effect from a potential default. We will continue to watch the action in the short-term lending markets for clues if this is spiraling into something larger.
Individual Investor Sentiment Bounces Back Thu, Sep 23, 2021 Last week saw a massive decline in optimism according to the AAII's weekly investor sentiment survey. In fact, bullish sentiment saw its largest one-week decline in over two years. Even though the S&P 500 has technically declined more in the week leading up to this week's survey than last week's, sentiment actually improved with the percentage of respondents reporting as bullish rising from 22.4% to 29.9%. That was the biggest one-week increase since the first week of July, but the percentage of bullish respondents is still well below the past year's range. Even though there was a big pickup in bullish sentiment, bearish sentiment was only little changed. This reading only fell 0.1 percentage points to 39.3%. That remains at a level above anything observed since last fall. That means that mostly all of the gains to bullish sentiment this week borrowed heavily from the neutral camp. Neutral sentiment fell sharply this week shedding 7.4 percentage points. That was the biggest one-week decline since a 7.5 percentage point drop in the first week of August. We'd also note that while last week saw a big shift in sentiment among individual investors, this week, newsletter writers followed suit as bullish sentiment among that group fell below 50% to 47.1% for the lowest reading since May. Bearish sentiment meanwhile rose to 22.3% which is the highest reading since October 7th of last year.
September Seasonality Update Well. Seasonality is back. Everyone in the financial media has been talking about September seasonal weakness lately. And here we are in September and the market has sold off the 5% or so we projected last month. And it did so in the notoriously treacherous week after September quarterly options and futures expiration. Then as expected traders and fund managers bought the 5% dip as they have throughout this bull market rally with the blessing of the Federal Reserve’s continuing dovish tone and accommodative policy that they reinforced at the conclusion of yesterday’s FOMC meeting. We do not expect stocks to succumb to the October curse this year. That doesn’t rule out some downside disturbance, but we do not foresee an impending crash, massacre or big selloff of the sort that have given October it’s dubious reputation as the jinx month. Many of the same geopolitical, political, fundamental and technical headwinds we highlighted last month remain, as well as some others, so another 5% or so pullback is quite likely as Wall Street still may suffer from chronic “Octoberphobia.” We’ve been doing this for decades and this pullback was prototypical end of Q3 window dressing and institutional selling. Several factors weighed on the markets, but most had been there all year. So why did the market selling off this month? Seasonality.
Four Charts That Signal the Reopening Trade May Be Back Wednesday, September 29, 2021 Stocks have come a long way since the S&P 500 bear market low way back on March 23, 2020, but despite the general strength of the bull market we’ve seen two very different types of trades leading markets at different times. They include a “work-from-home” trade characterized by strength among large caps and growth-style oriented stocks, strong performance by U.S. stocks in particular, and well contained interest rates. At other times, we’ve seen a “reopening trade,” where mid- and small-cap stocks have performed well, cyclically-oriented value-style stocks have led, interest rates have pressed higher, and performance across geographical regions has been more even. For most of the last six months the work-from-home trade has dominated, but we’re seeing some signs of potential rotation toward a reopening theme once again. “It’s increasingly looking like the Delta-related surge in COVID-19 cases, while still dangerous, has passed its peak, and there are signals that markets may be anticipating the next stage of economic reopening,” said LPL Chief Market Strategist Ryan Detrick. “After a mid-summer head fake, we’re seeing signs that this time the rotation might stick.” It all starts with interest rates. The 10-year Treasury yield started to stabilize in early August, and since then we’ve seen steady movement higher as elevated inflation looks increasingly sticky in the near term, and markets start to anticipate global central bankers slowly winding down extraordinarily supportive monetary policy. The full transition to neutral policy will likely take years, and central banks will remain supportive for some time, but the change in direction does matter. Seeing the 10-year yield move higher despite stock losses on Tuesday may be a telling sign. A higher 10-year Treasury yield has supported financial sector stocks, which are the largest sector in the Russell 1000 Value Index. The breakout in relative strength compared to the August peak may signal a more sustainable change in direction this time. It’s still too early to call a reversal by value-style stocks overall, but financial sector strength helps. Rising interest rates also tend to increase the value of near-term earnings over less visible long-term earnings growth, which may also give value stocks an edge. While there are some signs of a reversal higher in the value trade, what we’ve seen so far isn’t persuasive in isolation. But added to the broader market signals, we see potential for further relative strength, particularly for cyclical value sectors. The relative strength of small caps looks more robust, breaking out to the upside after treading water for several months. Small caps went through a stretch of extraordinarily strong performance between September 2020 and March 2021, and it’s not completely surprising that they gave back a good share of those gains after coming so far so fast, but we still think the economic environment is likely to be supportive for small- and mid-caps compared to large. We’ve been anticipating a rotation back to the reopening trade for some time. If you look at the charts there’s really been relative stability between the two themes since mid-July, but the last few weeks have provided solid signals of a potential reversal. With the latest surge in COVID-19 cases likely past peak, vaccination rates slowly rising, and economic surprises starting to come back into balance after a series of disappointments, it’s no surprise to see the shift toward the reopening theme. But there are some potential economic negatives that support this trade as well, such as high commodity prices, higher interest rates, and growing risk of stickier inflation. Nevertheless, we think the fundamental backdrop for equities remains positive on the whole, and we continue to recommend modest overweights to equities while leaning into cyclically-oriented value sectors and tilting away from large caps.
Could There Be An October Crash? Thursday, September 30, 2021 “October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” Mark Twain Well, it was bound to end eventually, but the S&P 500 Index will finish September in the red, ending an incredible seven month win streak. As we noted last month, these long win streaks actually tend to be quite bullish for future returns, with the S&P 500 higher six months later 13 out of 14 times. Yes, stocks were down some in September, but this still bodes well for the near-term. Speaking of the near term, here comes October. As Marc Twain explained many years ago, October has long been a source of anxiety for stock investors. “October is known for some spectacular crashes and many expect bad things to happen again this year. 1929, 1987, and 2008 all come to mind when we think about this month,” explained LPL Financial Chief Market Strategist Ryan Detrick. “But the truth is this month is simply misunderstood, as historically it is about an average month.” As the LPL Chart of the Day shows, since 1950, October ranks as the 7th best month, while the past 10 and 20 years it ranks as the 4th best month. In a post-election year it comes in 5th. So October clearly isn’t one of the best months of the year, but by no means is it the worst either. Now, let’s be very clear though, October is known for volatility. No month has seen more 1% moves (up or down) than October, with some of the largest 1-day moves (both up and down) taking place this month. Heck, the S&P 500 hasn’t had a 5% pullback all year (the average year sees about three) and the last one was nearly a full year ago, one of the longest such streaks ever. Not to mention the S&P 500 has now gone an incredible 317 trading days in a row above its 200-day moving average, one of the longest streaks ever. What we are getting at is a 5-7% pullback could potentially come at any time given we haven’t had one in so long. Here are some other interesting statistics to think about regarding the S&P 500 in October. It has been 21 years (2000) since October didn’t close at least up or down 1%. Several percent moves up or down are quite common for this month in other words. For six years in a row October has alternated between higher and lower. Given 2020 it was in the red, it could be time for a bounce in 2021. (More on this below) The last two times the S&P 500 was up more than 15% year-to-date heading into October, stocks gained each time (2013 and 2019). The author’s birthday is on October 28, one of the historically most bullish days of the year. Coincidence? It turns out stocks don’t like politics much. The S&P 500 performs much better in odd numbered years than even years. Remember, even numbered years have elections and midterms in November. Some pre-election jitters makes sense to us, which could bode well for 2021. Don’t forget the fourth quarter is historically the best for stocks, with the third quarter the worst. Stocks rise 3.8% on average during the fourth quarter, but the past seven times the S&P 500 was up 15% year-to-date heading into the home stretch of the year, the fourth quarter was higher every single time, up a very impressive 5.8%. In other words, should there be any October scares, investors may want to use the weakness as an opportunity to add to core positions.
