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On track — Week of May 24, 2021

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

indexwtdytd1 year3 years5 yearsindex level
S&P 500 Index-0.3911.2842.1117.1317.374,155.86
Dow Jones Industrial Average-0.4312.6142.1213.5317.0034,207.84
Russell 2000 Small Cap-0.4112.5466.2912.0416.282,215.27
NASDAQ Composite0.334.8144.8023.3524.3813,470.99
MSCI Europe, Australasia & Far East1.079.4142.197.4510.652,314.63
MSCI Emerging Markets1.753.5346.218.2714.151,330.04
Barclays U.S. Aggregate Bond Index0.07-2.63-0.435.363.222,329.13
Merrill Lynch Intermediate Municipal0.070.344.674.963.14318.19

As of market close May 21, 2021. Returns in percent.

 

On Track

May is turning out to be its usual consolidation self. In most Mays stocks slide sideways or wander slightly higher. Certainly, that is where we find ourselves heading into the final week of the month. Last Wednesday’s release of the Fed’s meeting minutes renewed the musical chairs rotation among sectors. More on the Fed in a moment. 

The tech-heavy NASDAQ has struggled since its closing record on February 12. Since then, pro-cyclical value sectors rode the Recovery Race winning vaccine wave to new highs at tech’s expense. Financials, Materials and Industrials have moved to the head of the performance class this year. However, their teens and 20-plus percent returns pale in comparison to the energy sector’s 38.5% rebound. 

Wednesday’s Fed news gave new life to the tech theme and pushed tech to its first weekly gain in the last four. Tech’s rotation up to the front row again pushed Recovery themes to the rear of the line. Small and mid-cap indices continue to tread water. International and emerging market stocks are slowing improving as Europe starts to reopen and India’s case counts continue to fall. 

Interest rates have stayed in a narrow one-tenth of a percent range this month, generating yawns among traders. When bond yields did move slightly, they resumed their pre-pandemic behavior, rising in price when stocks fell. Most commodities also had a down week, reflecting trader’s beliefs that the rate of recovery may slow somewhat in the coming weeks. 

Up

The Federal Reserve’s Open Market Committee meets eight times per year. The minutes are usually released about a month after each meeting. Markets rarely have a reaction because Committee members are out on the road speaking about the same topics. The April minutes were the exception. Last Wednesday’s release kicked the market theme from Recovery over to Expansion. Recovery mode for the Fed has centered around liquidity facilities for companies, states and cities, along with monthly purchases of Treasury bonds and mortgage securities. The liquidity facilities largely went unused and were wound down during the fall. 

The Fed’s buying spree, called quantitative easing, remains in place. The monthly $120 billion in purchases of bonds has pushed the Fed’s balance sheet past $7.5 trillion, or one-third of GDP. When the Fed buys bonds, it sends dollars to the selling bank. The bank then holds the dollars as excess reserves. Note that excess reserves are not lent out as loans into the economy. That is why quantitative easing has not resulted in consumer inflation over the last decade or in the last 20 years it has been used in Japan. “QE” does pull down market interest rates, pushing bond prices higher. This does create cheaper loan and mortgage rates. 

The meeting minutes stated that the QE program was working well, and there was no statement of slowing down (“tapering”) or stopping the program. The minutes did note that some members raised the idea that discussions about tapering should begin at some point. We think the Fed begins to publicly talk about tapering around the Jackson Hole symposium in August. QE has served its purpose in lowering interest rates, and markets would quickly adjust to slightly higher long-term rates. We would point out that most of the growth in tech stocks occurred when long-term interest rates were double their 1.63% level of today. A continuation of the program for the coming months was enough to cheer tech stocks Thursday and Friday. 

Earnings

Earnings season for the first quarter is a wrap. FactSet says that with 95% of the companies reporting, the revenue growth rate over 2020 was 10.7%. That would be the highest top-line growth since a 12.5% spurt in the third quarter of 2011. Seventy-eight percent of the S&P 500 members beat revenue estimates. At the bottom of the income statement, 87% beat earnings per share estimates by an average of 22.8%. 

Retailers usually bring up the caboose of the earnings train, and their results were worth waiting for. Walmart’s adjusted earnings per share beat estimates by 38.5% and same store sales grew 6%. The company raised this quarter and full-year guidance to “high single digits” from “low single digits.” Management believes pent-up demand from in-store shoppers will continue throughout 2021. Macy’s, once tossed aside as a mall casualty, beat estimates, and like Walmart, raised full-year guidance. Management stated that its online strategy was a source of strength. Three cheers for Macy’s beating the naysayers. Back to the stand-alone box stores, Home Depot beat estimates by 26%, and same-store comparable sales were up 31% versus estimates of 20%. Finally, Target pulled a Home Depot, blowing estimates for comparable sales +22.9% versus 10.1% estimated. Digital sales fell from 22% of sales to 18% in the prior quarter. That suggests to us that folks were willing to “go and spend” rather than “click and spend.” 

The first quarter of 2021 will be hard to top in terms of the magnitude of earnings beating estimates. We think that all of 2021 will see S&P 500 companies post solid earnings gains. The third and fourth quarters will likely show growth of mid-single digits as earnings were improving rapidly in late 2020. Regardless of the slowing earnings growth rate, healing consumers enjoying a strong labor market, and stimulus savings will keep spending growing. 

Down

Speaking of slowing, Citigroup tracks whether economic data did better or worse than economist’s estimates. You might think, that like weather forecasters, economists should be an easy group to beat. But not so fast. Most developed countries put out pretty good data sets, and the U.S. puts out volumes. Every region around the globe that Citi tracks through its Economic Surprise series have turned lower. The U.S. series has tipped negative – the most recent economic releases are just below analyst forecasts. Bear in mind that all the statistics continue to sit near or just below all-time highs. The U.S. series has posted positive readings for 248 trading days, the longest streak since the index began in 2003. 

An example of all-time highs is Markit’s survey of U.S. Purchasing Managers. The monthly indices of manufacturers and service industries have a number of categories and uses a diffusion method. This type of index registers a 50 if there is no change in the results from the previous month. A 40 is near recession, and 60 reading would mean that area is running hot versus history. The May readings hit records as more areas reopened. Manufacturing PMI rose 1 point to 61.5 above estimates of 60.5. New orders grew at a record rate, and output expanded at the fastest rate in four months. Services activity surged 5.4 points, a big jump, to a new record of 70.1. These readings are impressive, but we wonder how soon the Recovery wave will crest and start to settle back to more normal supply and demand. 

Jobless claims and existing home sales continue to trend down. Jobless claims fell to a pandemic low of 444,000, still above the pre-COVID levels of 220,000 but going the right direction. Existing home sales fell 2.7% in April versus March. The third monthly decline in a row is the result of vanishing inventory. The National Association of REALTORS considers a six-month supply a “balanced” inventory. Over the last several months inventories have headed down, hovering around two months. The national average for listing days on market is 17. We would bet Texas is much lower. 

Wrap-Up

Inflation is still the topic du jour. Supply chains will take longer to unkink and return to smooth operation. Prices for commodities will remain elevated for the balance of the year. We think consumer prices will stay at or above the 3% level for longer than the “transitory” several months the Fed desires. There is some pent-up demand, but most of the higher demand numbers we are seeing are in travel and leisure industries. One surprise for us was the parking garage at Love Field last Saturday morning. Garage B was full, the first time in several years we could remember seeing that sign. And this happened with school still in session. 

Consolidations can be time- or price-based. Time consolidations can take anywhere from two to ten weeks of aimless back and forth. Price consolidations usually result in 5% to 7% drops. We prefer waiting through time consolidations. Interest rates remain trendless, waiting on news from the Fed later this summer. 

Economic news this week should confirm our thesis that April activity was strong but likely not as strong as March’s reopening surge. New home sales, durable goods orders (Boeing planes), personal income and spending are the headliners. 

Our expected returns remain positive for stocks for the year, risks are skewed to the upside, and our indicator ranks are keeping us overweight stocks and underweight bond duration for the moment.



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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