LPL: A Tale of Two Months
Thursday, July 1, 2021
U.S. and international equities
The U.S. major market indexes were mostly higher during the month of June. Last month’s top performer, the Dow Jones Industrial, was June’s laggard. Moreover, May’s laggard, the Nasdaq composite, was this month’s top performer. International developed markets (MSCI EAFE) lagged emerging markets (MSCI EM) during the month.
What goes up…
The last two months for the market saw a reversal of fortunes for many of its winners and laggards. Information technology led all sectors in June by a fairly wide margin after being a laggard in May. Materials, financials, and industrials underperformed the broad market this month but they were all solid performers last month. The same pattern can be seen with the consumer discretionary and communication services sectors as well over the past two months.
This same relationship is prevalent when analyzing the international markets. As stated above, the emerging markets outperformed the international developed markets in June. This was the opposite case last month.
In addition, both gold and silver were strong performers in May as these metals returned approximately 7% each. In June, however, both metals finished the month lower and were among the worst performers.
As the markets have historically shown, not all patterns are completely consistent. What goes up does not always reverse course. The energy sector is an excellent example of this. This sector still is the best performing sector this year and almost double the second best performing sector — financials. With the price of West Texas Intermediate oil over $73 a barrel, well over the $50 breakeven price, and above many energy producer’s marginal cost, energy companies’ fortunes have vastly improved compared to last year. Both oil and natural gas had a solid June.
May’s fixed income results
The benchmark Bloomberg Barclays U.S. Aggregate Index finished the month marginally higher, as fixed income investors continue to take solace in the Fed’s policy stance concerning inflation. Municipals (Bloomberg Barclays Municipal index) and its high yield counterparts (Bloomberg Barclays High Yield Municipal Index) have performed well for three straight months. These bonds have been aided by municipal support in a number of fiscal stimulus packages along with the discussion of higher taxes. The Bloomberg Barclay High Yield Municipal Index has gained almost 6% this year, making it the top performing fixed income sector year-to-date.
International bonds (FTSE World Government Bond Index) ended the month lower, while the index yield rose. Emerging markets debt, as measured by the JP Morgan Emerging Markets Bond Index (EMBI), ended the month of June higher as the yield declined.
“Interest in growth stocks returned with a vengeance in June as Technology names come back to the fore and value stock leadership faded,” explained LPL Research Senior Vice President and Director of Research Marc Zabicki. “Meanwhile, long-term Treasury yields remained stubbornly low despite indications the Fed is growing more cognizant of inflation pressures. We believe, forward return profiles still favor equities, but now is not the time to take excessive risk.”
U.S. economic data recap
Inflation: Consumer prices increased for the third straight month in May. The headline Consumer Price Index (CPI) annual rise was the largest since August 2008. One major reason for the increase were the base-effects due to the depressed economic conditions last year due to COVID-19. Removing volatile food and energy prices, the May core Consumer Price Index increased over 3.5% from May 2020. This was its largest increase since June 1992.
Producer prices in May increased at its fastest rate on record. Year-over-year, the May PPI increased over 6.5%, while its month-over-month increase was almost 1.0%. May’s inflation showed to be quite substantial; however, we believe any inflationary pressure will mostly prove transitory.
U.S. consumer: The Conference Board’s Consumer Confidence Index held steady in May following April’s gain, which was the highest reading since February 2020. The Present Situations Index also increased again in May.
The University of Michigan consumer sentiment survey increased almost 3% in June. However, the reading missed economist’s expectations. That being said, it was still the second strongest reading since the vaccination rollout began.
Retail sales: Retail sales declined more than expected in May; falling over 1% on a month-to-month basis. The decline marked a change in consumer spending from larger purchases, such as home furnishings, to goods and services related to entertainment and travel. Spending at restaurants and bars rose to above pre-pandemic levels. Retail spending in May, however, increased almost 30% on a year to year basis.
U.S. home sales: Home sales in the U.S. increased in May at its fastest pace on record and reached a new high. That being said, rising home prices and low inventory are driving potential buyers out of the market. The median existing home price in May was over $350,000, which was up almost 25% from May 2020. Moreover, last month’s home value increase marks over 100 straight months of year-over-year price gains.
Small business sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index slipped in May. This was the first decline in four months. Over the past couple of months, the NFIB report has expressed concern about a tightening job market. In May, 48% of business owners reported unfillable job openings, which represents an all-time record high. This, most likely, will cause additional upward pressure on wages and compensation. In addition, the NFIB noted inflation as a concern with 43% of respondent stating that they plan to raise prices in the next three months.
Federal Reserve (Fed) news: The Federal Reserve (Fed), after its June Federal Open Market Committee (FOMC) meeting, made no changes to current monetary policy, as most market participants expected. However, more Fed members expect two quarter-point interest rate hikes in 2023, which was sooner than expected.
U.S. employment: The U.S. unemployment rate has declined substantially from last year’s peak but at 5.8%, it is still well off full employment levels. Even as we successfully handle the COVID-19 mitigation efforts and reopen the economy, labor market slack needs to improve in order for the economy to reach full-employment.
For quite some time, investors have been focused on COVID-19 cases and their effect on the economic reopening efforts. However, given the most recent inflation data, market participants will be focused more on inflation and its effect on the Fed and interest rates, the economy, and corporate profits. Strong earnings have been an important driver of this year’s strong stock market performance, however, markets are forward-looking. The ability for companies to successfully absorb higher input costs and pass them onto their consumers will play an important role in future earnings results. July could prove an interesting month given that 2ndquarter earnings reports will be released.
The Fed, along with LPL Research, believe that inflation is mostly transitory and will stabilize once the economy completes its reopening and supply chains are fully operational. As noted earlier, labor shortages could be a critical hurdle to overcome. To conclude, the major question that market participants want answered is how long the “transitory” period will last and what impact that may have on Fed policy, interest rates, economic growth, and corporate profits. This theme will most likely influence the rest of this year’s market performance.