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Inflate — Week of June 14, 2021

Written by Steve Orr, Chief Investment Officer, and Greg Kalb, Investment Advisor

indexwtdytd1 year3 years5 yearsindex level
S&P 500 Index0.4313.8335.2617.2817.384,247.44
Dow Jones Industrial Average-0.7813.6530.3313.3716.7134,479.60
Russell 2000 Small Cap2.1818.7360.9213.1816.452,335.81
NASDAQ Composite1.859.5041.5023.6824.8214,069.42
MSCI Europe, Australasia & Far East0.3211.9431.548.6311.012,365.09
MSCI Emerging Markets-0.157.5439.419.4713.871,378.85
Barclays U.S. Aggregate Bond Index0.53-1.650.045.523.182,352.59
Merrill Lynch Intermediate Municipal0.361.014.224.963.19320.32

As of market close June 11, 2021. Returns in percent.



Do stocks like inflation? Is the recovery over? One could get confused looking at last week’s results. Monthly inflation indices hit multi-decade highs, and the S&P 500 crawled to a new record. The headline Consumer Price Index rose 5% year over year in May. Half of the May increase was due to new and used cars and rental car pricing. Another large part of recent increases is due to “base effects.” These are the calculations that start with the price changes occurring a year ago. Remember that for March, April and May 2020 the monthly changes in inflation were -0.22%, -0.67% and 0%. Prices were falling during 2020 shutdowns, and recovery shortages are now pushing them higher. 

In June and July of 2020, the monthly index price changes shifted back to positive territory at +0.5%. Combine those with peaking commodity and other prices over the last three weeks and CPI may have peaked or will peak in the next month or two. While the evidence suggests CPI price increases are cresting, we believe CPI will remain elevated. Do not be surprised if CPI stays north of 3% for the balance of the year. 

Markets took the news in stride for two reasons. First, the above comparisons to falling prices in 2020 and, second, “non-pandemic” items in the CPI remain relatively tame. Pandemic items include furniture, apparel, used cars (up 7%) and car rental fees (up +12%). These categories are in demand shock as reopenings release pent-up demand. On the supply side, all suffer from delivery and/or production problems. Stocks look six to 12 months ahead and are discounting these “transitory” short-term effects. We remain in the Trannnsitory Camp, which is a fake term meaning we think high prices stick around into next year. 


Once the stimulus funding was completed last quarter the Treasury has cut the amount of bonds it issues. Lower supply and prospects for slightly lower inflation meant it was time for traders to buy tech and cover bond shorts. Traders pushed Treasury yields lower by 0.15% to 0.2%, hitting three-month lows. Less than one-quarter of a point does not seem like a big deal, but in the bond world it is a big move. 

Deflating yields boost the valuations of long-duration growth companies. On cue last week consumer discretionary and tech stocks rallied, helping growth-style stocks take the performance lead for the quarter. Value sectors like industrials, materials and transports had their worst week in months. We do not expect these lower rates to stick around.


More Meetings

Traders are eagerly awaiting this week’s Federal Open Market Committee meeting. Either the post-meeting press statement or Chairman Powell’s press conference may shed light on whether the Fed is ready to consider lowering its purchases of Treasury and mortgage securities. This buying program, or quantitative easing, started this time last year to support markets during the shutdowns. The Fed’s monthly buying of $120 billion in securities has successfully kept longer-term interest rates largely in check over the last year. 

Recall back in April and May the 10-year Treasury note rose from 1.5% to 1.7% as the Treasury increased the supply of debt to pay for Congress’ stimulus programs. Once the supply dwindled, so did rates. The Fed is not anticipated to make any other policy changes this week, and we believe one or two more meetings will pass before the Fed issues any guidance as to the current Quantitative Easing program. The Kansas City Fed hosts an annual economic forum in Jackson Hole in August. This forum usually has several position papers presented from the Fed or other economists on topics such as QE and may be where we first hear of possible program changes. 


How Many?

JOLTS, the BLS index of job openings, hit a record 9.28 million in April. Coincidentally, that is about the same number of folks who are unemployed. Workers who are getting jobs are leaving the unemployment rolls. Unemployment claims fell for the sixth straight week. The 376,000 net new claims are another post-shutdown low. Continuing claims are also falling, indicating that more folks are finding work and leaving the unemployment rolls. Just in time, too, as 22 states are leaving the $300-per-week supplemental unemployment program. The first few states quit the program last Saturday. Less unemployment money should increase payroll numbers in the coming months. Our base scenario is for 400,000+ in the June (survey is this week) and September reports, with the remainder of 2021 averaging 300,000.

Payroll growth of 2.3 million sounds excellent in “normal” times. Some context is in order versus the 9 million unemployed. The cycle low for unemployment was September 2019. That month the BLS estimated the unemployment rate to be 3.5%. At the same time, the estimate of unemployed workers sat at just over 5 million. Unemployment never goes to zero for several reasons. If we can agree that getting down to 5 million unemployed would be close to “full” employment as we had in 2019, then the economy needs to absorb 4 million more workers from the ranks of the unemployed. Or does it? How many more jobs need to be created to reach “full”? 

Estimates are that at least 1 million Boomers took early retirement during the pandemic. A conservative estimate of frictional unemployment could be another million. These are folks that are not in the right locations for job openings, do not have the right skills, or are unaware of job openings. Subtracting all the above from the 9 million unemployed figure gets the unemployed count near the September 2019 low. And if our analysis is on the right track, the biggest jobs gains have peaked along with many other measures. 


Stocks remain in a seasonal sideways consolidation. This is an ideal time to review positions and prepare to invest funds. Interest rates are not reflecting the strong economy and Fed QE changes down the road. We believe both will push rates higher later in the year. Lower interest rates combined with falling volatility and higher stock prices sound like a Goldilocks just-right scenario. History suggests favorable long-term returns, but in the five times since 1990 that this setup has occurred, Bespoke Research tells us short-term stock returns have been a bit bumpy.

Several foreign stock markets are looking toward post-virus recovery and moving higher. As a group they have a way to go before catching the U.S., but we are mindful that longer-term cycles suggest they will have their day in the sun. Our economic indicators remain bright green, and this week’s numbers should reinforce our view of 7% to 8% GDP growth this quarter. Retail sales in May likely rose 0.5% over April, excluding car sales. Industrial production and manufacturing indices also should show strong results. 

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary's University School of Law. Follow him on Twitter here. Greg Kalb is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts from The University of Texas at Austin.