Equity markets rose this week after inflation climbed higher and consumer sentiment beat expectations. While several high impact economic releases take place this week such as retail sales, industrial production, and PMI readings, all eyes are likely fixed on the FOMC announcement Wednesday. There is now a good chance that the Fed will announce a faster rate of asset tapering, with the underlying understanding that the purpose of a faster taper is to clear the way for rate increases next year. Some believe that markets have priced in a higher rate of taper along with rate increases in the first half of next year; Wednesday will reveal whether or not that is actually the case. While economic progress continues its long slog toward recovery, residual effects of the pandemic lockdowns continue to drag on the global economy. While shortages of everything from microprocessors to natural gas appear to be slowly improving, supply chains remain the number one obstacle to a more robust recovery. Overall, markets have performed well YTD, but headwinds continue to fiercely resist further progress.
Overseas, developed markets outperformed emerging markets, with both indices returning positive performance. European indices were positive, while Japanese markets followed suit with positive performance. Improving prospects against the pandemic as well as improved prospects for economic recovery should continue to help lift markets globally over time, but macroeconomic factors such as inflation and supply shortages threaten markets everywhere.
Equity markets were positive this week as investors continue to assess the state of the global economy. While fears concerning global stability and health overall appear to be in decline, the recent volatility serves as a great reminder of why it is so important to remain committed to a long-term plan and maintain a well-diversified portfolio. When stocks struggle to gain traction, other asset classes such as gold, REITs, and US Treasury bonds can prove to be more stable. Flashy news headlines can make it tempting to make knee-jerk decisions, but sticking to a strategy and maintaining a portfolio consistent with your goals and risk tolerance can lead to smoother returns and a better probability for long-term success.
Chart of the Week
Unemployment claims have been on steady decline, registering the lowest level in more than 50 years this week. The labor market is clearly recovering, but overall the labor market still has quite a bit of ground to recover to get back to pre pandemic levels.
Broad market equity indices finished the week up with major large cap indices outperforming small cap. Economic data has been mostly encouraging, but the global recovery still has a long way to go to recover from COVID-19 lockdowns.
S&P sectors were positive this week. Technology and energy outperformed, returning 5.98% and 3.69% respectively. Utilities and consumer discretionary underperformed, posting 2.55% and 2.52% respectively. Energy has the lead in 2021 with a 50.49% return.
Oil rose this week as crude oil inventories shrunk. Energy markets have been highly volatile in the COVID era, but it appears that higher oil prices may be more of the norm given recent market fundamentals. Demand is down compared to early 2020, but as global economies are continuing to improve, oil consumption is recovering rapidly. On the supply side, operating oil rigs are still well under early 2020 numbers, but trending upwards. In addition to supply and demand, a volatile dollar is likely to have a large impact on commodity prices.
A new dimension has emerged recently in energy markets. China recently has been unable to produce the energy needed to keep its power grid running without interruption. Additionally, Europe and other regions have struggled to acquire enough supply of natural gas to meet anticipated heating needs for winter. Many analysts are anticipating high and possibly rising natural gas prices as countries desperately try to fill shortfalls before the weather turns too cold. Additionally, concerns over manufacturing operations in China could remain for some time.
Gold rose negligibly this week as the U.S. dollar recorded no net change over the prior week. Gold is a common “safe haven” asset, typically rising during times of market stress. Focus for gold has shifted again to include not just global macroeconomics surrounding COVID-19 damage and recovery efforts, but also inflation and its possible impact on U.S. dollar value.
Yields on 10-year Treasuries rose this week from 1.3430 to 1.4837 while traditional bond indices fell. Treasury yield movements reflect general risk outlook, and tend to track overall investor sentiment. Expected increases in future inflation risk have helped elevate yields since pandemic era lows in rates. Treasury yields will continue to be a focus as analysts watch for signs of changing market conditions.
High-yield bonds rose this week as spreads tightened. High-yield bonds are likely to have stabilized for the short term as the Fed has adopted a remarkably accommodative monetary stance and major economic risk factors subside, likely helping stabilize volatility.
A headwind could be on the horizon for fixed income assets, as the Fed has begun tapering its asset purchases which could raise yields. Tapering will undoubtedly have an impact on yields, but the degree of impact is uncertain. In addition to asset tapering, it is becoming increasingly likely that the Fed will be raising interest rates in 2022, adding additional price risk to fixed income assets.
Lesson to be Learned
The individual investor should act consistently as an investor and not as a speculator. This means... that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money's worth for his purchase."
FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).In a nutshell, we want the RPI to be low on a scale of 1 to 100. For the US Equity Bull/Bear indicator, we want it to read at least 66.67% bullish. When those two things occur, our research shows market performance is typically stronger, with less volatility.
The Recession Probability Index (RPI) has a current reading of 27.58, forecasting a lower potential for an economic contraction (warning of recession risk). The Bull/Bear indicator is currently 100% bullish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).
It can be easy to become distracted from our long-term goals and chase returns when markets are volatile and uncertain. It is because of the allure of these distractions that having a plan and remaining disciplined is mission critical for long term success. Focusing on the long-run can help minimize the negative impact emotions can have on your portfolio and increase your chances for success over time.
The Week Ahead
This week will see updates to retail sales, PMI readings, and industrial production. Most importantly, the Fed will be providing updated guidance on its outlook for monetary policy going into 2022.
More to come soon. Stay tuned.