Markets logged their 7th straight winning month in August with economic gains and strong corporate earnings continuing to propel markets higher. While the Delta variant has dented some of this momentum, the gradual increase in vaccinations has proven to be a bulwark against a deeper slowdown, with experts suggesting that Delta may already have peaked. The impact has primarily been limited to travel and leisure sectors, such as airlines, and sectors most sensitive to continued growth. This has allowed the market to largely ‘look through’ this period, although leadership has largely shifted back to technology companies as cyclicals peter out.
Nevertheless, there are a number of moving variables starting to exert a stronger pull on the market which warrant close attention. First, the Fed’s accommodative policy has largely underpinned the rally, and coming out of their recent Jackson Hole meeting have indicated a willingness to begin reversing this policy. Price increases caused by supply chain bottlenecks and dramatic changes in demand are putting some heat on the Fed to begin moderating these effects. At the same time, they are still looking to see more inclusive job gains before beginning this process, and the job market has been quite choppy of late. Despite a continued drop in the unemployment rate, the rate of new hiring has dramatically slowed, and many sectors are still experiencing labor shortages. While the recent expiry of unemployment benefits may grease the wheels, there is a clear structural mismatch in the labor markets that has been slow to adjust.
The Fed also wants to preserve its flexibility in case the economy suddenly slows in coming months, and they need to remain accommodative. Already there are indications of a general slowdown in global growth, with Chinese factory output and retail sales slowing and a slew of US companies moderating their forward-looking guidance. Wall Street banks have likewise lowered their US GDP estimates, and relatively low treasury yields right now are signaling the same. This dichotomy underscores the challenge the Fed faces in ‘threading the needle’ and means that uncertainty is likely to remain elevated for the next several months as they decide what to do. The latest inflation and jobs numbers will certainly factor into these decisions, as there has largely been an assumption that some of the more worrying data is transitory in nature due to the pandemic. They are looking to see some of these ‘hot’ data points ‘cool down’ over the next several months.
In terms of markets, this elevated uncertainty has translated into a shift of leadership, with the mega cap tech largely in the driver’s seat in recent weeks while the ‘recovery stocks’ that led in the first half of the year have slowed down. For example, airlines and energy sectors are 15-20% off their highs while the FAANGs are broadly within a few percentage points of their respective highs. Nevertheless, the slowdown of economic gains and general de-risking in the market has pulled the market down a little bit in just the last week. And it’s been less about Tech as a category outperforming as much as it has been about ‘flight to quality’ within the Tech and other sectors more broadly. Many more pure-play growth and speculative areas of the market remain well below the highs.
Indeed, markets like to trade on stories, and we are just a little bit in between narratives right now with the Fed and a variety of economic data at key inflection points. The market’s also simply up nearly 20% YTD, which is an incredible run by any measure, so a little profit taking is only natural as would be a potential correction. However, we continue to view fundamentals as incredibly solid, with stocks still cheaper relative to earnings than they were on January 1. So while markets feel due for a little choppiness we welcome any volatility as an opportunity to add value in portfolios, and will be ready to do so if the opportunity arises.