July turned out to be a rather interesting month for investors as the Dow Industrials and S&P500 large cap stock indexes continued their move to new all-time high levels. This happened as the mid-cap index was relatively flat and small caps printed a negative return. To our surprise, the Aggregate Bond Index rallied with the large cap indices! The dollar weakened within its current range as commodities, again, posted a solid monthly increase.
The big outlier this month was the MSCI Emerging Markets Index which turned negative for the year as it posted a 7.5% loss for the month. This is directly related to issues related to China, which has a weighting of more than a third of the index.
All data as of 07/01/2021, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
For the past few years it has become a running joke around the office of what happens to corporate earnings projections over the course of a calendar year. In a typical year we hear great things for the following year around November, followed by earnings “revisions” downward in the following 7 or 8 months. There’s always a reason, and almost always assurances that better-than-expected earnings are going to happen, we just haven’t gotten there yet. It usually starts with assurances that earnings will be better in the second half of the year before morphing into some variation of “next year is when earnings will really start to kick in.”
Knowing that the phrase “this time is different” is the worst possible statement one can make when it comes to the markets, but when it comes to earnings projections, this year really has been different. What started out as expected S&P500 earnings of $150-$160 for 2021 has become a real possibility of $200 of earnings.
We entered August with approximately 40% of S&P500 companies reporting second quarter numbers with 82% of reporting companies beating earnings expectations and 84% exceeding revenue projections. Amazing is an understatement. The beats are across all sectors, many of the excess returns are by large margins. And this is happening as global supply chains aren’t working properly and consumer demands aren’t able to be met. All you need to do is drive by a car dealership or go into a bicycle shot to see the lack of inventory available. Good luck finding a contractor to do work at your house.
But here’s the thing …
The stock market isn’t rational, nor does it react in a predictable manner. With great earnings does not always come great stock price increases. Sometimes what’s good is bad. Yet sometimes what’s good is good. Confusing, we know.
Right now, the stock market is in a rather interesting position. Economically we are in the expansion phase of the economic cycle. In this phase credit growth tends to be strong, profit growth eventually peaks, as does economic growth. Given the strong corporate profits and economic growth (6.5% second quarter real GDP growth), we wouldn’t be surprised if this is as good as it gets for the stock market. We wouldn’t be surprised if this were close to the top of the economic cycle.
Except this cycle is working out in a different manner than a “normal” economic cycle. Inventories, which usually fill up around the top of the cycle are still extremely low. Consumer demand continues to be strong as low inventories have pushed back demand instead of pulling it forward. Job growth has been strong yet we are not even close to peak employment numbers. Clearly, what is different in this cycle is the excess savings many Americans have from not spending during the pandemic lockdown in 2020 and a supply chain that cannot fulfil the current demand for goods.
From our perspective we expect to see economic growth slow for the torrid pace of the first half of this year, but to remain above the baseline 2% real GDP growth rate as the supply-demand disconnect resolves itself. We believe the top of the economic cycle will be in sight when inventories have substantially increased and demand for goods has returned to normal. In practical terms, peak economy will be a time when your local car dealership has a full parking lot with tv commercials touting the latest and greatest sales offers.
Big picture the outlook remains bright.
Summer Doldrums or Summer Fun?
Over the next few months we MAY be dealing with a rocky stock market for three reasons. First, the S&P 500 (see chart #1) is looking a bit “toppy” to us right now. Markets don’t move up or down in a straight line, which is essentially what has happened since the beginning of the year. There were some days that didn’t feel great but the largest drawdown so far in 2021 has been 4% off the all-time highs. In our world that’s, like, zero volatility (although not really). We also know that, historically, the August-September-October time period is not very good for equities. Finally, the blowout numbers we saw for corporate earnings didn’t propel the overall market higher. Instead, the earnings were so good it spooked the markets.
Chart #1: Source: www.stockcharts.com
Until we start to see a breakdown in our big three indicators – economic growth, corporate earnings, or higher interest rate environment – we don’t expect any “correction” to be very large nor deep. There’s also the real possibility the markets simply correct over time, moving within a sideways range. Our point: this is not a big concern, just something to be aware of.
Chart #2: Source: www.stockcharts.com
Something we have been keeping an eye on are the emerging markets, the worst performing asset class we follow. Political pressure from the Chinese Government on large (mainly technology) Chinese companies has been the cause behind the selloff. You can read up on what’s going on here, here and here. With Hong Kong stocks comprising 31% (where a lot of Chinese companies are listed), Taiwan 13.75%, and China 6.5% of the index, this is an important development.
Chart #3: Source: www.stockcharts.com
Chart #4: Source: www.stockcharts.com
Stay Invested Even When You Hear Negative News
For some of you this is easy to do because you do not pay attention to the day-to-day happenings of the market. For others, this is a big ask because, well, you do pay attention to the noise surrounding the markets and economy. Please, please, please, fight the urge.
There are always reasons to not invest. There are always reasons to wait to put your savings to work. Yet you cannot participate in the gains if you are always waiting for the “right time to invest.” Here are some examples:
- 20 years ago investors were facing the 9/11 terror attack, the fallout from the dot.com bubble and record bankruptcies being recorded.
- 10 years ago investors were faced with US Treasury bond credit rating downgraded from AAA status and a spike in the price of oil and gasoline
- 1 year ago we were dealing with a global pandemic.
As bad as those events were, markets were resilient and investors who stuck with it were rewarded for their patience.
The past few years have been good ones for investors who stayed the course. With a growing economy, a continued low interest rate environment, and surprisingly good corporate earnings investors have done well. While we do expect bumps along the road, that’s all we expect them to be – bumps.
We remain bullish on the stock market for the long term.
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com