Tricks Or Treats For Markets?
As a child, Halloween was one of my favorite holidays because of all the - you guessed it - candy! It was one of two holidays as a child where eating as much candy until you got sick was allowed (at least back then). However, the disturbing aspect of Halloween, as a child, was the horror element. As an adult, I'm not ashamed to admit I'm still a little skittish when I see a Michael Myers mask. Interesting trivia about the iconic mask - John Carpenter, creator of the Halloween series of movies, found the mask at a store in 1977 during filming of the original "Halloween" movie.
The mask was actually a Captain Kirk (William Shatner) mask that Carpenter found and decided to use for his villain. Though Star Trek originally aired in the late 1960s on television, the show had become more popular in reruns during the late 1970s. Carpenter was drawn by the expressionless face of the mask, which he thought would capture the essence of his villain - it worked! Carpenter did alter the mask slightly, though, by removing the "space sideburns," painting the face of the mask white, and increasing the size of the eye holes. As a side note, contrary to recent social media posts, Michael Myers is an equal opportunity serial killer.
And so, as masks are not always what they seem, so too are markets, economies, and policymakers not what they seem. Here's what we're seeing so far this week...
Bond Market Could Surprise - And Not In A Good Way. The yield on the 10-year Treasury bond before Thursday had reached 1.64%. Yields have moved slightly higher today after poor 7yr auctions. Yesterday, the 10-year yield settled in at 1.57%. With the rise in inflation, it's possible this round of Tapering by the Fed, unlike 2013, could be a larger shock to the system.
When Tapering began in 2013, inflation on a year-over-year basis was only 1.5%. This year, just prior to Tapering, inflation is 5.4% (3.5x more than the level in 2013). There is a possibility that in addition to bond prices moving with Tapering, an exodus from bonds into equities could be a larger shock than we saw in 2013. A scenario where the yield on the 10-year Treasury reaches 2.5% is not altogether impossible. Shipping backlogs, strong consumer demand, and throw in an energy crunch for good measure, and you have yourself the potential for bonds to massively under-perform. You see, bonds are already under water for the year as the Bloomberg US Aggregate Bond Index is down 1.6% year-to-date. On an inflation-adjusted basis, the index is down more than 6%. Meanwhile, equities, as measured by the S&P 500, are up 23% year-to-date and still up 17% after inflation. If the 10yr yield does get to 2.5%, that would likely put the Aggregate Bond Index down another 4-5% on top of where it is today.
Equities The Better Choice? As equity valuations get stretched, one would think that investors could cool on that asset class. Depending upon future growth prospects, that is a possibility. However, with the rise in yields and increasing inflation, equities look like the more attractive option. The good news on this front is that the recent rise off the market bottom of October 4th has been broad in nature.
All 11 sectors of the S&P 500 are higher since the the market made it's three-month low. If you're looking at investing in equities versus bonds, the S&P 500 index has a yield of 1.3%, which is just behind that of the Bloomberg US Aggregate Bond Index at 1.4%. So, you get a yield close to bonds and a superior total return with equities, which makes the asset class more attractive at this point in time. The Conference Board's measure of Consumer Confidence not only beat analysts' expectations of a decline, but also surpassed last month's reading. New Home Sales were up much higher in September. Later this week we'll get a look at Personal Income and Consumer Spending to get some idea on how long the consumer can keep this economy going in the backdrop of higher costs and low supply of goods.
No Help At The Ports. There hasn't been much progress on the shipping bottleneck at the ports. It was been estimated that there is approximately 30 million tons of goods sitting on container ships anchored off U.S. ports, just ahead of the holiday season. Just yesterday, officials at the Long Beach and Los Angeles ports announced a new fine on shipping companies effective November 1st for containers left in the marine terminals for more than 9 days. I would not anticipate this to help resolve the problem as there are not enough truck drivers available to remove the containers even if companies wished to comply.
On quarterly earnings calls, there has been a massive increase in the concern over supply chain issues being discussed. You can see from the chart on the left that more than 350 companies have mentioned supply bottleneck on their quarterly calls - a jump from about 250 during the 2nd quarter. In fact, Andy Jassy, Amazon CEO, said on their earnings call just yesterday, "In the fourth quarter, we expect to incur several billion dollars of additional costs in our Consumer business as we manage through labor supply shortages, increased wage costs, global supply chain issues, and increased freight and shipping costs." In addition, Apple missed their Q3 earnings expectations as CEO Tim Cook said supply chain issues cost the company approximately $6 billion in revenues. If the situation does not resolve itself, there is little chance that inflationary pressures ease anytime soon. Investment firms such as Goldman Sachs and Morgan Stanley are expecting the shipping crisis to continue into the middle of next year.
Economic Data Appears Stable, For Now. The economic releases this week have been positive overall. Growth definitely waned during the 3rd quarter, but the Labor Market continues to slowly improve.
Yesterday, 3rd quarter GDP came in lower, but not as bad as it could have been. Growth came in at only 2%, versus the 2.6% expected. The deceleration was led by a slowdown in consumer spending, which dropped from 12% in Q2 to 1.6% in Q3. This was largely due to supply-chain issues. The largest detractors from GDP were personal consumption of motor vehicles (-2.4%) and personal consumption of durable goods (-2.7%). Durable Goods being appliances, motor vehicles, computers. Delivery of these items are delayed 6-8 months, so consumers have adjusted.
On the bright side, both Initial Claims and Continued Claims dropped week-over-week. Initial Claims dropped by 10,000 and hit a new pandemic low.
Continued Claims also set a pandemic low coming in at 2.2 million versus 2.4 million expected. It's amazing that Continued Claims have dropped by 665,000 since the announcement of pandemic-related benefits were ending. Imagine that - you take away people's incentive to sit on the couch and they get out there an get a job. Next week's Jobs Report is critical to see how many jobs have been added in the Transportation and Warehousing sectors. Those jobs could help ease the shipping bottleneck.
The National Financial Conditions Index (NFCI), maintained by the Chicago Federal Reserve, continues to show stability in markets and in the economy.
That index tracks more than 100 criteria of financial activity and for the past 6 months, the Index has not moved much despite all the market noise and headlines. Some additional economic data dropped this morning which was somewhat mixed. PCE Prices, a metric the Fed is more focused on as opposed to CPI, came in as expected with a 0.3% increase. However, the Employment Cost Index rose substantially (+1.3%) versus last quarter (+0.7%). We are seeing these costs beginning to be passed along to consumers and companies adjust in real-time. Companies such as Conagra, PepsiCo, and Lamb Weston have reported higher costs for consumer of their products due to labor shortages and supply chain issues. Companies such as McDonalds are exploring other ways to combat the labor shortage and increases to wages. The company recently reported a partnership with IBM to potentially automate their drive-thrus.
Despite the concerns, the St. Louis Federal Reserve maintains a Financial Stress Index that has been equally as stable as the NFCI. In fact, that index just moved to the lowest point since the pandemic began, also indicating that the economic situation here in the U.S. is stable. So for now, it seems investors should stay put, but monitoring the job shortages and shipping bottleneck should provide a clue as to future growth over the next few months.