THE WEEK ON WALL STREET
Rising bond yields dampened investor enthusiasm for high-multiple growth companies last week, sending market averages mostly lower in a holiday-shortened week of trading. The Dow Jones Industrial Average gained 0.11% for the week. But the Standard & Poor’s 500 fell 0.71% and the Nasdaq Composite index slid 1.57%. The MSCI EAFE index, which tracks developed overseas stock markets, declined 0.26%.
The 10-year Treasury Note yield hit its highest level in a year last week on worries of a pick-up in inflation, while the 30-year Treasury Bond yield ticked over 2.0%. Rising yields weighed on the high-valuation growth stocks, most specifically the big tech names, in addition to dragging down interest rate sensitive sectors, like utilities and real estate investment trusts (REITs). Economic data painted a mixed picture of the economy. Jobless claims reflected a still-struggling labor market while a strong retail sales number and an above-consensus PPI (Producer Price Index) reflected strong consumer spending and building inflationary pressures.
Stocks were flat as the week came to a close, as traders wrestled with the crosscurrents of positive economic data and a further rise in yields.
After a long period of low inflation, concerns are growing that higher consumer prices may return as a result of an accommodative Federal Reserve monetary policy and fiscal spending in response to the pandemic. Tensions heightened last week with the release of January’s PPI report, which saw a jump of 1.7%, the biggest monthly increase since 2009. While the Fed believes that any price increases will be fleeting, the market appears to view inflation a bit differently. The prospect of further stimulus and more reopenings are adding to investors’ unease, which may revive an old Wall Street practice—inflation watching.
THE WEEK AHEAD: KEY ECONOMIC DATA
Monday: Index of Leading Economic Indicators.
Tuesday: Consumer Confidence.
Wednesday: New Home Sales.
Thursday: Jobless Claims. Durable Goods Orders. GDP (Gross Domestic Product).
Friday: Consumer Sentiment.
THE WEEK AHEAD: NOTABLE COMPANIES REPORTING EARNINGS
Monday: Palo Alto Networks (PANW).
Tuesday: Home Depot (HD), Intuit, Inc. (INTU), Ingersoll Rand, Inc. (IR).
Wednesday: Nvidia (NVDA), Etsy, Inc. (ETSY), Lowe’s Companies (LOW), TJX Companies (TJX), Teledoc Health, Inc. (TDOC).
Thursday: Salesforce.com (CRM), Best Buy (BBY), Workday, Inc. (WDAY), Dell Technologies (DELL), VMware (VMW), American Tower Corp. (AMT).
Friday: Draftkings, Inc. (DKNG).
Inflation. This is the major question and theme that will play out in the markets the next several months.
While the government tracking methods insist inflation is a ways off, more anecdotal measures (like the cost of gas at the pump or groceries in the store) tell a different story. Interrupted supply chains, political red tape, and yes – Covid restrictions – continue to play a significant role in this saga. A look at the financial sector implies that rates may be rising soon. If all of this is true, interest rates would risk, multiples would decline, and indexes would likely decline in response.
The wild card is stimulus. It’s really an inflationary tool. The issue is, in the short-term, it changes buying behavior by stimulating the demand side of the curve first. People can literally buy more stuff, so they can drive prices (and profits) higher in the short-term. But longer-term, it changes the supply of money in circulation, reducing its purchasing power. The creates all kinds of knock-on effects in valuation formulas (especially in lending).
The market seems to be digesting all of this now. It would not be surprising if the P/E ratio of the S&P 500 began to decline toward more historic norms. Likely it will still remain higher than long-term averages, just not as high as it’s been.
Does this imply a major correction in the markets? Not necessarily.
If corporate earnings continue to climb – which they very well may, given the probability of stimulus driving demand – earnings could climb while P/E ratios decline. In effect, we could see a sort of sideways market where both variables more or less cancel each other out. If this is the case, the 4000 level on the S&P 500 could become a bit of a plateau for a while as the index oscillates around it for an earnings season or two while markets figure out where things are going.
History, of course, teaches us that markets can remain irrational for longer than expected (and certainly longer than you can remain solvent). So, it’s not to suggest prices can’t go higher. It’s to suggest prices are very expensive in certain areas of the market if we see interest rates rise.
And that’s really the key: this market is now built on low interest rates. Any change to this would create systemic shockwaves.
The Fed has more or less opened its playbook up and is telling everyone the calls before they make them. “Rates will stay low” is basically the message. But if for any reason this story changes, things could get interesting quickly.
For this week, the question is whether or not the market resumes its P/E climb, or if there is more shake-down to come after last week’s sideway move.