The workweek started early with Federal Reserve Chairman Powell appearing on CBS’s 60 Minutes on Sunday night. The narrative was all about a strong acceleration in the economic trajectory:
“…we’re at a place where the economy’s about to start growing much more quickly and job creation coming in much more quickly… we and a lot of private-sector forecasters see strong growth and strong job creation starting right now. So really, the outlook has brightened substantially.”
Retail sales, jobless claims and manufacturing indices were all announced on April 15 and either generally or greatly exceeded expectations. This data indicated that the Fed Chairman was right and that a “re-opening” is well underway.
The earnings season also kicked off this week. Our observation is that guidance will be more important than reported earnings. Since 2020 was such an aberration and the subsequent economic rebound greatly varied according to industry, reported earnings have become even less important relative to a company’s guidance. Investors want guidance to help decipher the projected post-pandemic world and corporate executives are the ones providing the road map in their earnings calls.
From a forward-looking perspective, FactSet consensus estimates for Q1 S&P 500 index are for +6.4% revenue growth and earnings per share (EPS) growth of +24.5%. It is interesting to note that the Financials sector is expected to contribute over 40% of overall S&P 500 earnings growth. Mid-week, Goldman Sachs, JPMorgan, Wells Fargo, Bank of America, Citigroup and U.S. Bancorp reported their 1Q 2021 earnings results. In general, revenues and earnings substantially exceeded expectations. The stock price reactions were muted to lower. The principal stock price moves were precipitated by guidance versus the reported results.
The guidance for other sectors will have to be rather exceptional in the short run for continued positive performance of many indices. If this is not the case, we would expect to see some volatility in the short run. Studies of 4Q 2020 have shown that many S&P 500 companies that reported earnings that exceeded consensus earnings actually underperformed the S&P 500 index. It was only those companies that provided guidance of more than 5% above consensus that meaningfully outperformed. This is something to be watched as the financial sector is clearly very important to the market.
Guidance with regard to margins will also be especially important. A key question will be to what extent rising input costs will be passed on to the consumer. Unexpected rising input costs and disrupted supply chains will not be looked on favorably. Which companies will have pricing power? Many households have unusually large savings due to decreased spending during the pandemic. Perhaps some companies will be able to increase prices. Relying on a single supply chain often proved problematic during the pandemic and so many companies are now seeking to diversify their supply chains. This could lead to a persistently higher level of input costs. Shipping cost (freight rates) increases also appear to be more permanent. Contract shipping rates for trade between Asia and North America are now 25% to 50% higher year over year (“Y/Y”). (Bloomberg, April 12 referring to S&P Global Platts data).
Why do we care so much about the components of possible inflation? It is because we are trying to decipher what’s temporary versus permanent. Is inflation a moving target? A more persistent inflationary period would lead to higher interest rates and would be indicative of a more beneficial environment for cyclical and value stocks.
This past week, far higher than expected CPI (consumer price index) and PPI (producer price index) numbers were met with muted market reactions indicating that the inflation data was already mostly priced into the markets. The Federal Reserve continues to believe that any inflation spikes will be temporary because inflation expectations will remain subdued. But once inflation expectations rise, inflation increases may become more entrenched.
What does recent economic data indicate about the timing and extent of various countries’ economic growth trajectories? Our view is U.S. economic growth is strong and rising. Given that China’s economy is strong and is expected to be on a lower trajectory, the U.S. will assume a leadership role in the global recovery. EU (Europe) and then EM’s (emerging market countries) will later follow. This “rolling” acceleration should help prolong the economic rebound. This too should ultimately be favorable for cyclical and value stocks.
We believe a big part of the U.S. ascendancy is that it continues to lead most countries in vaccination rates. The U.K. is starting to close the gap relative to the U.S. EU is not that far behind. EM’s continue to lag. The vaccination rates are expected to be a leading indicator of a country’s economic revival. The temporary suspension of the Johnson & Johnson vaccine probably will change vaccination rates only modestly. Goldman Sachs reduced their estimates for the vaccination rates of EU and Canada by about 2% to 3%.
It was an important week for cryptocurrency. The highly anticipated Coinbase direct listing came public this week at a premium valuation and Bitcoin hit a record high early on the morning of the listing. We believe that the Coinbase public listing helps legitimize the acceptance of Bitcoin as a separate asset class by institutional investors. This is a story in its infancy and is well worth watching.
On Friday, China reported GDP growth for 1Q 2021at +18.3% Y/Y versus expectations of about 19.0%. March industrial production was +14.1% Y/Y versus 18.3% expected. Fixed asset investment also disappointed at +19.4% Y/Y in March versus +35.0% Y/Y for the January – February period this year. Retail sales were +34.2% Y/Y vs expected +28.0%. . We interpret the data to show that while the consumer is stronger, Chinese policymakers seem to have adopted a less accommodative approach towards certain investments. While the numbers are very impressive, China’s slightly slower trajectory supports our relative overweight to the US.
Price action of U.S. equities, interest rates and USD have all shown this week that much of the very strong inflation and economic data may have already been priced into stocks. This confirms the general trends of recent weeks. Many cyclical and value stocks have recently underperformed. Daily volatility has sometimes varied from these recent trends. The sector components of the S&P 500 index have shifted on a daily basis, showing the advantage of a balanced equity portfolio. The 10 year Treasury yield has traded lower, especially on April 15th, when very strong economic data was announced.
The USD also traded lower this week – more optimism that other countries’ economies will soon show a more convincing rebound as their vaccination rates accelerate. It would not be a surprise if more volatility were to occur in the short term. That said, the “rolling” positive economic performance of the global recovery should extend the economic rebound. This scenario should lead to higher interest rates and be beneficial for stocks, especially cyclical and value-oriented investments. Most likely, the recent underperformance of the “re-opening” trade will only be a pause. In short, we expect the longer-term prospects of the re-opening of the economy to overpower the tepid market responses to date.