Markets Close Lower Despite Good Earnings and Data on Delta and Inflation Fears

Summary

– S&P 500 closed lower on the week at 4,327.16, which is down from 4,369.55 last week.

– Despite hovering near all-time highs, the chop of July is being felt acutely.

– We are expecting a continuing strong showing in earnings led by Epicenter sectors and reflationary names.

– Inflation uncertainty continues, but many adjacent markets are showing signs of immense strength, making us think the current volatility will likely be short-lived.

The S&P 500 had its first losing week after three up weeks in a row. Today witnessed some positive numbers in retail and earnings. Still, the continued prevalence of inflationary pressure, which markets aren’t sure is transitory or not, led to weakness that accelerated into the close. Over the last month, Technology has been the leader, and the Epicenter/Reflation trade underperformed. Interestingly, the day the highest inflation number in 13 years crossed the tape, bond yields pretty much hovered flat. We live in strange times for financial markets that certainly seem more characterized by anomalous events than historical correlations.

However, with all the complex drivers and unprecedented liquidity, some may doubt whether certain data provides an intelligible signal or just noise. Price discovery in debt markets may be distorted not only by the massive amounts of liquidity but also by its relative value in a world with $14.7 trillion in negative-yielding debt instruments.

Did bond yields drop to 1.25% for any other reason than there is a lot of money looking for safety around? It’s hard to tell. The 30-yr, often used as a proxy for long-term inflation expectations, has been calming down, which clashes with short-term data. That short-term data is coming in hotter than any time in a while, and it seems from Chairman Powell’s testimony this week that GOP polls are honing in on what usually is the domain of financial geeks for a potentially potent political issue. Runaway price pressures have historically been a mighty political force that is the bane of incumbents, going back to the days of peasant revolts and bread riots. Whether or not the flush US consumer will be receptive to inflation talking points in 15 months or not is undoubtedly the question of the day. Some political operators seem to be betting it will be.

Let’s take a close look at the inflation numbers because, whatever side you may be on a number of issues, hyperbole is definitely big business these days. If hyperbole were a commodity, it would probably have beat lumber and the rest combined in yearly gains. This prevalence can distort and dramatize our thinking. There are pieces of data that certainly give credence to the Fed’s transitory narrative, and there are other data points that suggest there’s more to what the inflation hawks are saying than nostalgia for the 1970s. So, friends, let’s dive in a little deeper into factors driving the inflation headline numbers.

The CPI reading came in at 5.4% in June, the highest reading in over a decade. The components that really brought the numbers up were the undeniably astronomical readings of 40% growth plus in the prices of gasoline and used cars. Despite this parabolic rise, these components only account for roughly 7% of the total CPI reading. Shelter and food, which comprise over 50% of the reading, were up 2.6% and 2.4%, respectively. So there it is. Right? These are the major inflation drivers that would signal a secular change, and they are well above Powell’s target of 2%. So, is it time to get out your disco gear? Probably not quite yet, considering that the growth in these two significant components averaged above both readings at 2.7%. So technically, these major drivers are experiencing slight deflationary pressure in the aggregate, although it is essentially flat.

Not so fast. The Beige Book, a unique source that polls many different businesses across different districts, directly found that most surveyed companies did not expect severe inflationary pressures to subside soon. So, firms are beginning to feel the heat in terms of inputs like raw materials and labor, and these prices are being passed on to consumers. More businesses raised prices than at any time since 1981.

Another prevalent factor found in the Beige Book and elsewhere is a common post-plague development of workers holding greater leverage, despite the NFIB finding higher than expected optimism at the small-business level. This is pretty remarkable given that a record-high 39% of businesses raised wages since 46% of them couldn’t fill open vacancies. It’s not as if there’s a lack of people looking either because, according to Jolts, 9 million people who want jobs can’t find them.

Perhaps this mismatch will partially be rectified by one of our major investing themes, the rise of AI/Automation. If you’re going to look at the labor market’s bad and problematic aspects, you should also examine what’s going right. Since the COVID-19 crisis began, the growth in output per hour worked has risen at a historically high rate of 3.4%. The last business cycle averaged at a relatively paltry 1.4%. So the innovation we repeatedly highlight in Epicenter stocks is making a macroeconomic impact.

One thing is for sure, we live in incredible and unpredictable times, and there’s a lot of fiscal and monetary uncertainty in the air. Nothing wrong with a bit of a breather in July after the eleventh best first half since 1928. Hang in there. There are many indicators suggesting equity markets are incredibly strong. For example, the ETF inflows for this year are less than $10 billion away from the previous annual record. We’d remind you that we recently raised our YE target for the S&P 500 to 4,600 and firmly believe that the market will be guided upward by higher earnings after the day’s uncertainties have passed.