Tracking the supply chain
Problems with the “supply chain” have been a key topic among investors, consumers, business managers, and political leaders. While we cannot offer an easy fix for what is an extremely complex and global issue, we can identify some potentially useful quantitative metrics to watch to help track developments in the supply chain, rather than relying on interesting but unreliable anecdotal evidence (e.g. what product you couldn’t find at the store yesterday).
Moderate correction provoked a sharp drop in bullishness
The S&P 500 recently had its biggest pullback since March, though only about 5% from its early September all-time high and thus quite mild in the context of normal market volatility historically. The Russell 2000 has not hit a new high since mid-March but was also only about 5% off that peak, having been mostly range-bound since then. Major indices have since recovered much of those declines in the last week and are again approaching their highs.
Time to take profits in Financials?
As Q3 earnings season gets underway, stocks in the Financials sector are in focus as they are typically among the first to report earnings. While history indicates companies are on average likely to beat Q3 estimates, our indicators, which have been supportive for Financials all year, are now starting to weaken and suggest it might be time to take profits in the sector and reallocate to other areas.
Big moves in energy markets
Volatility in the crude oil and natural gas markets has been a big topic among investors and policy makers recently. Limited supplies and higher demand are pushing prices higher, and stock prices in the Energy sector are responding.
The chart below helps put recent movements in perspective, seen in the context of the last five years. Crude oil prices (second section, in red) have just recently topped their 2018 peak, completing a full recovery from the COVID-related drop and weakness that preceded COVID. But the five-year average for crude oil has been about $55/bbl, with a low of $25 (on this measure, which uses an average of the next 12 months of crude oil futures contracts to avoid near-contract distortions) and a current high of $76. So crude is elevated but not at an extraordinary level given it was at about the same price in October 2018. And it reached much higher levels above $100/bbl. back in 2008, 2011, and 2012.
Q3 earnings should be good, but uncertainty remains high
As Q3 ends and with reporting season set to begin in the coming weeks, we can update the current consensus earnings outlooks for Q3 and Q4 as well as calendar year 2021 and 2022 for the S&P 500. Earnings should be up a lot from last year, but uncertainty among analysts remains quite high.
For Q3, S&P 500 earnings are expected to be up 28% from a year ago according to Factset, another big percentage gain. That figure is higher than it was at the start of the quarter (it was 24% on June 30th) but has been stable since July and down marginally since the end of August. So the pace of gains in aggregate index earnings has eased, but estimates are still rising modestly on balance.
Fed dodging another taper tantrum
The primary news from the Fed meeting yesterday was to clarify the likely timing of reducing and then ending the current QE (quantitative easing, or bond buying) program. Fed Chair Powell indicated that (barring any big surprises) the tapering would begin at the next FOMC (Federal Open Market Committee) meeting in early November and aim to be completed (bond buying would end) by the middle of 2022. This would be a somewhat quicker move to end QE than occurred previously, but markets seem prepared for this and thus unlikely to have a “taper tantrum” again.
Fundamental momentum slowing for Cyclical sectors
For some time we have noted that traditional Cyclical and Value sectors have had much stronger earnings estimate revisions activity (“fundamental momentum”) than Growth or Defensive sectors. That has been changing recently as cyclical sector estimates are less strong than before, and Growth and Defensive are holding up better. Thus we have recently been looking more favorably on certain Growth or Defensive sectors and neutralizing exposure to Cyclical/Value areas.
What is stagflation and is it making a comeback?
A frequent question lately has been: are we currently in, or about to enter, a period of “stagflation” like the late 1960s and 1970s as a result of COVID and policy responses? Our short answer is no: while inflation may be elevated for a while, growth is currently strong, structural inflation pressures are low, and policy is better now than in the 1970s, making any sustained stagflation conditions unlikely. Below we offer some historical context and our current views.
Emerging Markets fundamental momentum still very weak
In our regional allocation work, we have been underweight in Emerging Markets relative to developed markets since May, and remain so currently. A key reason for our continued underweight stance is that the relative fundamental momentum for emerging markets remains very weak compared to that of the broader global equity market.
The chart below shows one of our popular composite indicator charts based on the relative performance of the widely-followed MSCI Emerging Markets ETF, ticker EEM, versus the broad global benchmark of the MSCI All-Country World Index (ACWI) ETF, represented by ticker ACWI.
Supportive and predictable policy helping keep equity volatility low
Major equity indices globally have been remarkably stable in recent months, pushing realized volatility readings to very low levels.
Our own research along with that of many others has shown that volatility in equities tends to be persistent in the shorter-term, while tending to mean-revert in the long-term.
Beyond the movements of a single index like the MSCI ACWI or S&P 500, we can also see that the average three-month volatility across a broad array of major developed markets individually is extremely low (chart below). This average of 18 countries’ volatility (based on their respective MSCI country equity benchmark index) is in the bottom decile of its 10-year range right now. This means that it is not just the dominant US market that has had low volatility, nor is it only the diversification effects that can dampen volatility in a broad global index, it is in fact a global pattern of low equity market volatility across many markets.