Stocks have rallied this week as messaging from the Fed suggests no tapering decision before the November meeting. The Jackson Hole meeting, virtual this year, will be held at the end of this week and feature comments from Fed Chairman Jerome Powell. While he may discuss conditions that he looks for to institute tapering, he is unlikely to go much further, leaving that decision to the FOMC. While the next FOMC meeting could firm up a timetable to begin slowing bond purchases, unless growth and inflation data is exceptionally robust in the interim, a decision likely will be deferred until November or even later.
Recent data has been decidedly mixed and impacted by the Covid-19 Delta variant. The good news is that there are convincing signs that case counts are starting to roll over in some of the southern states hit early on. The character of most surges to date has been fast spread followed by an equally fast taper. That suggests most of the country will have passed peak levels before the end of September. In the interim, however, returns to offices have been curtailed by many, masking has reappeared, and there has been a definite slowdown in airline and cruise ship bookings, as well as restaurant reservations. But this isn’t a repeat of 2020, and we expect that as the surge loses steam Americans will quickly go back to where they were before Delta’s emergence. With that said, how schools reopen will cause some disruption. Many schools in the South, already into the Fall semester, have had to go virtual or otherwise adapt as unvaccinated school children are getting sick. It will be several more weeks at the earliest before emergency use authorizations are possible for children ages 5-12, and there will likely be parental reticence to allow kids to be vaccinated, especially if the surge shows signs of abating.
As vaccination rates continue to increase, and more people have been sickened to date, it is likely that any further surges should be less than the current one. With that said, with schools back in attendance and more people gradually returning to work, there will be a higher incidence of colds and flu this Fall and Winter. Separating Covid-19 from the other illnesses will be a challenge. Thus, while overall economic growth will continue, the pace will likely continue to be impacted by health concerns for at least the next few months.
The 10-year Treasury yield has traded within a fairly narrow range for the last couple of months. Even as inflation has increased, markets have sloughed that off. Whether it is due to ongoing Fed bond purchases pushing rates lower, or fears of a slower pace of growth than originally forecasted, is debatable. It is likely a combination of both, but the stability in the bond market allows the Fed to take a slower path toward future monetary easing and pushes back the likelihood of any rate increases in 2022.
While some price spikes have clearly abated (e.g., lumber, oil, used cars), wages and rents keep rising. The extended unemployment benefits will end for all around Labor Day. We should begin to see in September whether those taking the summer off while enjoying the extra government handouts will start to seek new jobs. What we do know is that there are millions more jobs available than there are unemployed workers. Restaurants can’t fully reopen due to a shortage of waiters and kitchen help. Transportation costs have spiked amid a shortage of truck drivers and higher fuel costs. Covid-related impacts in China have slowed the loading and departure of container ships. Supermarkets cannot get complete orders filled. Supply chains are still a mess.
There is only one way to alleviate shortages. Higher prices. Workers can demand more money and better conditions. Suppliers get higher prices for goods in short supply. Companies are working hard to catch up, but no one opens up a toilet paper factory to satisfy at 3-month shortage. They may work an extra shift until supply/demand balance is restored. There is too much economic uncertainty for anyone to dramatically increase production unless supply shortfalls are to be sustained for years, not months. For the Fed and for investors, the big question is how much of the supply chain disruption is temporary. Will a temporary surge in production be enough to restore balance, or are shortages (and higher prices) likely to be more enduring?
In a month or so, there might be better definition as to the Fed’s tapering game plan, even if precise details are delayed until November or so. As peak acceleration in the economy passes and more focus shifts to the speed at which growth slows, the Fed will adapt. Thus, the game plan to be announced this Fall is likely to be modified before completion.
So, why the equity strength this week?
1. Growth, although slowing, is still solid. Sales of existing and new homes are rising again. Recent price spikes slowed demand while increasing listings. I wouldn’t say balance is totally restored, but the frenzy of late Spring is over. The same can be said for used cars. New car dealer lots are still barren, but no one is chasing used cars selling above former list prices unless the need is critical.
2. Shortages limit growth but help margins. There is little question that pricing power has shifted from buyer to seller across the board.
3. 10-year Treasury yields are not going up, even as the stock market moves back into record-high territory.
4. The dollar seems to have lost some steam. As the dollar value falls back a bit, commodity prices rally.
5. Leadership names like Microsoft# and Alphabet# continue to set new highs. There isn’t going to be a bear market or even a minor correction unless these stocks show some weakness.
6. Bitcoin is up 70% in a little over a month, a sign that speculative fever is back, fueled by all the monetary excesses around. Meme stocks are also surging, an obvious sign that too much money is seeking speculative returns.
7. Most importantly, the Jackson Hole conference, once seen as a turning point in the Fed policy roadmap, now seems to be a non-event, with action likely to be deferred until the Fall. Investors are waiting for the Fed to walk the walk, not talk the talk.
Normally, markets in good years have good finishes, but complacency is always dangerous. When the Fed actually starts easing, bond yields could rise and pressure stock valuations. Democrats will come back to Congress next month with a goal of passing almost $5 trillion of new spending, funded by lots of new or increased taxes including income taxes on corporations. No tax increases have been factored into equity prices yet. Supply shortages could disrupt Christmas season. Paying attention to asset allocation is never a bad idea.
Today, actress Blake Lively is 34. Rachael Ray is 53. Miley Cyrus’ dad, Billie Ray, turns 60. Donald Trump’s former best friend, Michael Cohen, is 55. Finally, Gene Simmons, the co-lead singer of Kiss, is 72. He was born in Israel as Chaim Weitz. Not sure whether his tongue was hanging out as a infant or not.
James M. Meyer, CFA 610-260-2220