Our Top Market Takeaways for July 23, 2021.
Market thoughts: A wild ride
After a bad case of the Mondays, investors swooped in to buy the dip. Cyclical stocks (those most tied to the ebb and flow of the economy) and growth stocks (such as big tech firms) rallied in tandem, and 10-year Treasury yields popped back up to ~1.30% after sinking to as low as 1.17%. It seems that a strong start to earnings season is doing much to outweigh concerns over the spread of the Delta variant and peaking growth data. Heading into Friday, the S&P 500 was just 40 basis points from its all-time high.
Rollercoaster weeks like this one are bound to come around again, and with that said, it’s worth examining the drivers behind the recent volatility. Here are five thoughts on markets this week.
1. The Delta variant seemed to be at the center of this week’s wild ride (although positioning dynamics, inflation, growth concerns and the idea of the “same old Fed” aren’t off the table).
The variant represents a growing share of new COVID-19 cases, and has led some economies to reimpose tighter mobility restrictions. Los Angeles reinstated indoor mask requirements. Music was just banned in Mykonos. Sydney has tightened lockdown measures. Athletes in Japan for the Olympics have been testing positive.
Let’s hone in on the United Kingdom, where the spread has been acute despite the nation boasting one of the highest vaccination rates in the world (68% of the population has received at least one dose). The Delta variant accounts for nearly all cases over the last 15 days, and new daily cases are over 40,000 for the first time since January.
Although cases are on the rise, it’s critical to note that hospitalizations and deaths both remain low. This suggests that: 1) vaccines are still working to protect the population, even if they’re less effective than they were versus earlier strains of the virus; 2) the demographic of infected people is younger; and 3) we have more informed standards of care.
And even if case counts get substantially worse before they get better, hospital utilization rates remain far lower than where they were at the peak of the COVID-19 crisis, suggesting that healthcare systems in vaccinated countries are unlikely to be overwhelmed.
This matters for reopening. After all, the United Kingdom just ended the majority of its COVID restrictions on Monday (including mask wearing and social distancing). Globally, stringency measures are broadly on the decline. It’s possible the Delta variant will cause policymakers to implement some restrictions on the margin (no mood music in Mykonos is a case in point), but we think it’s highly unlikely that we’ll see broad renewals of lockdown measures in developed economies.
2. That said, our base case hasn’t changed, but risks are in focus.
We think Monday’s weakness was a mere interruption of the bigger story (and the rest of the week’s price action seems to agree): The stock market should continue to advance in the coming years, driven in large part by earnings growth.
It’s also important to remember that market pricing reflects the full set of potential scenarios, and the spread of the Delta variant (or another mutation) increases the probability of the virus once again disrupting the economy (even if that probability remains low in our view). Nonetheless, as virus fears recede, we expect the market to turn its attention back to the potential for ~40% S&P 500 earnings growth in 2021 (followed by double-digit growth in 2022). That earnings growth will be a reflection of strong economic activity, robust consumption as excess savings get spent down, and healing in labor markets.
3. So when it comes to investing in stocks, we’re still advocating for a barbell approach between both cyclical and growth.
Cyclical areas of the market have taken a beating over the last several weeks. Even with the turnaround this week, materials (-8.5%), financials (-5.6%) and industrials (-2.1%) are all down from their recent highs, but they’re also the sectors that stand to see the largest earnings upside this year. Just look at Q2 expectations: Industrials alone are expected to grow their earnings over 300%versus the prior year. As earnings come to fruition and reopening finds its footing, we think cyclicals are poised for another leg higher through the second half of the year.
At the same time, growth stocks—many at the forefront of innovation—deserve a place in portfolios, especially given that broad returns are likely to moderate as the cycle progresses in much of the developed world. In particular, we urge investors to seek out opportunities in technology and healthcare.
Bottom line: Balance portfolio exposures between cyclical acceleration beneficiaries and secular growers.
4. It’s OK to seek ease of mind by de-risking.
When things get bumpy, it can feel good to do something. A few ideas:
The rate rally has been meaningful, and could offer an opportunity to fix liabilities and/or shorten duration (AKA leg into shorter maturity bonds that are less sensitive to changes in interest rates). Since the end of Q1, 10-year Treasury yields have fallen from 1.75% to ~1.30%. The list of reasons for lower yields is long, but these levels of rates aren’t consistent with our view of the future—we see above-trend growth into 2023 (as the vaccine rollout has more room to improve, labor markets are still healing, the consumer is healthy, and policy broadly remains accommodative), which should drive 10-year yields toward 2% over the next year.
At the same time, it could be an opportunity to protect broad equity market gains. The S&P 500 has rallied a whopping +95% from its COVID lows, and hedging or maintaining exposure with protection is an option.
5. Finally, remember that volatility is normal!
Since 1980, the S&P 500 has experienced an intra-year average maximum drawdown of -14%. Still, the index managed to post positive calendar year returns more than 75% of the time, suggesting that staying invested over the long run has paid off. Past performance isn’t indicative of future results, but we expect the stock market to digest and weather volatility as it occurs.
Even if we see more volatility ahead, we still think stocks will end the year higher than they started. Corporate earnings are robust, consumers are on solid footing, and the Federal Reserve will continue to watch incoming data before making its next move. Risks considered, our constructive outlook remains intact.
All market and economic data as of July 2021 and sourced from Bloomberg and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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