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Parabolas — Week of November 8, 2021

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

index wtd ytd 1-year 3-year 5-year index level
S&P 500 Index 2.03 26.54 38.44 21.85 19.82 4,701.72
Dow Jones Industrial Average 1.43 20.47 32.95 15.10 17.84 36,432.22
Russell 2000 Small Cap 6.11 24.34 52.38 17.81 17.40 2,442.74
NASDAQ Composite 3.08 24.61 38.83 30.88 27.18 15,982.36
MSCI Europe, Australasia & Far East 1.65 13.40 30.08 12.47 11.11 2,373.27
MSCI Emerging Markets -0.04 -0.18 13.96 11.24 10.35 1,264.07
Barclays U.S. Aggregate Bond Index 0.64 -0.95 -0.43 5.91 3.19 2,369.30
Merrill Lynch Intermediate Municipal 0.29 0.54 2.07 4.99 3.08 318.85

As of market close November 5, 2021. Returns in percent.

Parabolas

How about we review high school geometry this week? No bid? Ok, let’s just review one curve and one stock. You may remember that a parabolic curve starts higher slowly and then very rapidly rises nearly straight up before peaking and falling at the same rate it rose. In Bull markets stocks can rise in a parabolic arc but rarely fall back to the same level. Most of the time after peaking they consolidate at slightly lower levels, rebuilding energy. 

Tesla is the parabolic stock of the moment. Since the end of September, the car and battery maker has risen 58%. Several drivers pushed the stock higher: the Hertz and Avis electric announcements, hitting one trillion in market capitalization. The stock ranks sixth in market cap in the S&P 500 and in the NASDAQ. Both indices have benefited from Tesla’s latest move, hitting multiple new highs this last week. 

Happily, we can report that Tesla and tech are not the only sectors moving the market. Solid earnings reports and improving economic data from October have broadened the rally. Last Wednesday the S&P 600 and Russell 2000 small cap indices finally broke out to new records. Both had traded back and forth in a roughly 10% range since mid-March. Last Friday’s job report pushed small cap another 1.44% higher. We are also encouraged by the broad breadth in the small cap and equal-weighted indices.

Until Friday most of the major indices' up days posted 1.5 or 2 stocks higher for every 1 lower. Ho-hum. Friday’s positive price action gives us confidence in the rally. The S&P 500 had 4 stocks higher for every 1 lower and 314 stocks made new 1-year highs that day. That is on par with runs earlier this year. 

Small cap stocks still trail their large brethren for the year, but November’s stampede has closed the gap. Through Friday the S&P 600 small cap index rose 6.48% for the month, versus the mega-cap 500’s nice rise of 2.3%. Are small caps going parabolic, too? More likely small caps are signaling economic recovery.

Reopening Redux

October’s job report added fuel to the recovery (Reopening Round 3?) from the second quarter’s delta drag. The headline number of 531,000 net new jobs was comfortably above the consensus estimate of 450,000. Two important points buried in the press release: 1) September’s report was revised up to 312,000 from the initial report of 194,000, and 2) private payrolls increased 604,000. Quick math shows that a negative seasonal adjustment for teacher hiring lowered the headline number. The three-month average gain in non-education payrolls is running at a 490,000 rate. If activity over the last several months was held back by virus fears, early retirements and expanded benefits, then the next several months should show at least the same level of job gains, after seasonal adjustments. 

We are mindful that total employment remains about 4.2 million below the pre-pandemic peak. Take away the last 19 months of pandemic and the labor force participation rate might be close to 64% of the working age population. This would mean payrolls would have grown by about 2.8 million during those 19 months. In other words, the economy is short about 7 million jobs. This puts the BLS Job Openings survey at 10.3 million available jobs in context. On the supply side, the unemployment level continues to decline, estimated at 7.4 million last month. We still think the available workforce is closer to 4 million, reduced by Boomer retirements, skill levels, and the virus pivoting some workers’ priorities. 

The Plan

No surprise last Wednesday, the Fed left short-term rates unchanged and announced that it will reduce the amount of bonds it buys each month. A small surprise was the emphasis on “transitory” inflation. The Committee did acknowledge that “indicators of economic activity and employment have continued to strengthen.”

The Fed has no plans to raise short-term rates any time soon. The test for the Fed to raise short-term rates is a return to maximum employment and inflation averaging “2% over the longer run.” In contrast, futures markets are watching economic growth and inflation and believe the Fed will raise rates by one-quarter of a point at least two times in the second half of 2022.

The pace of the Fed’s pandemic quantitative easing program will be reduced over the next two months. The current program spends $120 billion per month buying U.S. Treasury and mortgage securities. In November and December, purchases will be reduced $15 billion ($10 billion less in Treasuries and $5 billion less in mortgages) per month. The Committee will reassess economic data at its January 26th meeting. If the recovery continues apace, the plan is for the Fed to end its bond buying program mid-summer of next year. Regardless of the taper pace, the Fed’s bond portfolio will reach $9 trillion and stay around that level for the foreseeable future. Even though much of the monies raised by the bond buying program remains trapped at the Fed, the portfolio supports a very accommodative monetary stance. 

Bothers

What events or fundamental forces could affect growth in the near term? Things that bother us remain constant: the next variant, interest rates and D.C. drama. 

A question we get is whether removing the Fed’s buying will cause interest rates to rise. In isolation we would say, yes, removing a big buyer would cause prices to fall, pushing rates up. Bear in mind that Congress is also winding up borrowing for stimulus CARES Act programs. We expect near-term Treasury bond issuance to fall, reducing supply. 

The deb drama sequel is scheduled for early December. The Senate may take up the House infrastructure & taxes bill any day now. The borrowing horizon for those programs is out over several years. We still expect rates to rise, but not a repeat of the dramatic 2013 Bernanke taper. 

Delta case counts continue to drop here in the U.S. Unfortunately, delta is now driving across Germany and Eastern Europe. Pfizer and Merck reported good results against the virus last week from new pill formulations. 

Wrap-Up

The delta variant dragged down third quarter growth. Another round of reopening clearly was underway in October. Retail sales will continue to look poor because of depressed auto sales. The consumer is in great shape and increasing employment correlates well with future stock earnings. 

We are impressed with the number of companies saying supply chains are manageable and guiding earnings higher for the full year. We are over halfway through earnings season and results are beating estimates by at least 11%. This week only 10 S&P 500 members report, led by PayPal and Hormel. 

Strong earnings, demand and crimped supplies of everything – labor, parts and commodities will keep companies hustling. They are keeping our economic and market indicators green, and portfolios fully invested.


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.

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