Hello again! I’m Johann Komander, Greenwood Gearhart’s Managing Director of Investments, and welcome back for our Monthly Market Moment for June. With the economic recovery strengthening markets are continuing to trade at all-time highs. Economic indicators such as industrial production and job creation continue to improve, and companies just finished reporting a blow-out 1st quarter. Nevertheless, market indices have traded within a narrow band over the past month and have struggled to break out higher. Despite the momentum, the economy is experiencing some growing pains as the sudden demand surge is dealing with a supply side that has yet to catch up. As a result, markets are still expressing some caution until it becomes clearer what’s temporary and what’s not.
This mismatch between supply and demand is being driven by several factors. First, in the effort to improve efficiency and reduce cost, global supply chains have migrated in recent years to “Just in Time” delivery and other lean inventory practices. When COVID struck last Spring, companies dramatically cut production due to the drop in demand. Now with demand surging they are finding themselves thin on inventory and struggling to keep up. Second, the nature of demand itself has changed in fundamental ways as a result of the pandemic, as the acceleration of trends such as remote work and e-commerce have fundamentally altered consumer behavior. This has meant sectors of the economy that are beneficiaries of these shifts, such as building materials and transportation, have found themselves underinvested and understaffed. Likewise, services sectors such as hotels and restaurants are suddenly in search of workers after a year of low demand.
This is in part why the job market is experiencing some tightness at the moment, with job openings exceeding new jobs taken even as the unemployment rate remains elevated. This mismatch will improve over time, as temporary factors such as unemployment benefits and the lack of child care abate. However, the skills mismatch will likely persist for some time until a combination of higher wages and workforce retraining bring about a better balance.
These factors help to explain why despite the resounding optimism borne out by the data markets are expressing a little hesitation. They are closely watching the Federal Reserve for any indications of a shift in their stance, which would have implications to interest rates and thus financial markets broadly. Nevertheless, every new data release helps to more fully paint that picture, helping markets build their forward expectations. As we progress, a few factors have been working in the market’s favor.
First, the data so far has been good but not too good. In other words, policy makers are seeing the improvements they want but not so great as the force them to tighten monetary policy faster than indicated. Inflation data has come in hot in recent months and yet the market has barely budged, indicating the market believes the Fed’s narrative that much of this is transitory. This is in part why interest rates have actually fallen in the last few weeks, with the 10-year treasury dipping down to below 1.5%. The Fed is already laying the groundwork for a reversal in some accommodative policies, such as its purchases of bonds, but nothing as of yet nothing that’s out of step with the expectations they’ve set.
Second, as corporate earnings continue to charge ahead stocks are becoming cheaper on a relative basis even as the price hardly moves. The S&P 500 is up over 13% year to date and yet its multiple to earnings has actually declined modestly. So as time goes on, the floor of fundamental value in the stock market is improving, and stocks should therefore be able to better weather volatility from future data surprises.
Lastly, some of the most worrisome factors, such as the steep rise in commodity prices, have stabilized and in some cases reversed course in recent weeks. For example, lumber prices have fallen 30% in the last month, with the froth in various other commodities subsiding as well. While still much higher than last year’s levels, this will help to temper future inflation prints as these data points and the depressed base prices from last year drop out of the calculation. Such dynamics suggest the market for goods and services is slowly working its way back to equilibrium, with some of the thorniest data possibly behind us.
So despite the heightened uncertainty there indications that slowly but surely the economy is balancing itself, all while it surges ahead at the fastest growth rate seen in decades. Thus, looking into the second half of the year we remain quite optimistic, while recognizing we’ve still likely got some choppiness ahead as the data pours in. We will be monitoring these developments closely and stand prepared to act in portfolios when opportunities arise.
Thanks again for tuning into the Market Moment for June. We welcome any comments or questions, and we wish you and your families well.