Weekly Market Update Highlights
• Last week’s modest pullback in U.S. equities may have been the result of overbought conditions, rather than fears of rampant inflation. The thesis for a bullish end to 2021 remains largely intact.
• The passage of a $1 trillion infrastructure bill had no immediate impact on equities, given extended valuations, but should be marginally positive for economic growth over the intermediate term.
• As earnings growth slows, investors are becoming more selective—choosing to reward (or punish) companies based on their earnings at a higher-than-average rate.
Hotter-than-expected inflation data took its toll on equity indexes within developed markets last week. Notably, the S&P 500 fell -0.3%, ending its streak of five weekly consecutive gains. The DJIA and tech-heavy NASDAQ fell -0.6% and -0.7%, respectively. The MSCI EM Index added 1.7%, largely due to a 3.5% gain in China, which was fueled by optimism over a potential softening tone regarding regulation. This, in turn, helped the ACWI ex USA rise 0.3% despite a loss of -0.3% for the EAFE Indexes.
Market Drivers And Risks
• October’s Consumer Price Index (CPI) hit a 30-year high, but that doesn’t mean an end to this bull market.
• The year-over-year CPI increase of 6.2% may seem alarming from a headline perspective, but equity markets took the number in stride. While prices have risen broadly, a deeper look reveals little change in the inflation pattern that has prevailed in 2021, with the highest levels of inflation concentrated mainly in areas of the economy most affected by temporary disruptions and distortions in supply/demand dynamics.
• In October, for example, the overwhelming majority of price increases came from only a few baskets. And even if inflation ultimately settles above pre-pandemic rates, we share the Fed’s view that these elevated levels will subside.
• The worst of last Wednesday’s market losses were within growth and technology stocks, given the sharp spike in long-term Treasury yields, while cyclicals and value outperformed. The S&P 500 pared its losses over the next two days, supporting our belief that the pullback was driven more by stretched valuations, rather than the beginning of a correction fueled by fears of inflation and diminished prospects for growth.
• The thesis for a year-end rally remains largely intact thanks to several factors, including earnings growth, an accommodative fiscal environment and the reduced likelihood of increased corporate taxes.
• The third-quarter earnings season essentially wrapped, with a blended earnings growth rate approaching 40%—outpacing our top-end estimate of 35%.
• Though we cheer earnings growth rates that top estimates, we are focused on how markets have reacted to both positive and negative earnings surprises. S&P 500 constituents with third quarter earnings that surprised to the upside (downside) have been rewarded (punished) at rates that exceed five-year averages. As expected, investors have grown more selective, favoring companies capable of defending and expanding margins by navigating supply chain disruptions and higher input costs – a trend we expect will persist.
Economic Week In Review
• Results were evenly split for the S&P 500 from a sector perspective. Consumer discretionary was the hardest hit, falling -3.2%, with the heaviest losses coming from auto manufacturers. The energy sector lost -1.3% as the Biden administration made it publicly known that it was considering releasing strategic oil reserves to battle rising energy prices. Five sectors were in positive territory, lead by materials, which rose 2.6% thanks to the passing of the $1T infrastructure-spending package last Monday.
• Last week investors received encouraging news related to global supply chains, as three of the world’s largest automotive manufacturers indicated that their production levels are returning to normal. As one of the industries hardest hit by supply chain disruptions, automakers are now fueling optimism that the worst of the semiconductor chip shortage may be behind us.