After nose diving early last week, equity markets recovered the losses, sending the S&P 500 into record territory by week’s end. Using the small cap index as proxy, the rally into Friday was not broad-based with technology and internet-based stocks enjoying the bulk of the week’s recovery. For the fifth consecutive week, growth outperformed value, with value falling behind year to date.
The TSX, despite energy stocks being battered in the week, managed a 2.27% gain. Year to date, the TSX is up a respectable 13.18%. The S&P 500, as mentioned, hit new highs, and closed out the week adding 1.96% bringing the year-to-date return to 17.46%. The Nasdaq was the big winner on the week, jumping 2.84%. The S&P400 Mid-cap Index rose 2.13% and the Russell 2000 added 2.13% to the year’s total gain. Both the S&P400 Mid-cap and the Russell 2000 Indices fell behind the larger cap S&P 500 year to date retuning 15.87% and 11.89% respectively. In Europe, except for the UK FTSE Index (up 0.28% and Germany’s Dax Index (gaining 0.83%), other indices gained over 1% in the week.
On Monday the 10-year US Treasury fell to the lowest level since February, further confusing investors thinking inflation and higher rates were a near term certainty. The drop was in part exacerbated by short sellers partially covering short positions and large pension funds rebalancing into equities. By Friday, rates bounced off the bottom, but at 1.28%, still considerably lower than the previous high set just a few months ago.
Investor sentiment started the week with fears that the spread and rising cases attributed to the delta Covid variant could slow economic growth and recovery. Positive Q2 earnings and revenues helped quell investor sentiment by Friday. According the latest FactSet data, 24% of S&P500 companies have reported with 88% beating EPS (earnings per share) estimates by an average of 19% — well above the five-year average of 7.8%. Earnings growth for Q2 was 74.2%. It should be remembered the growth rate is from a much lower base than normal due to Covid in Q2 of 2020. Energy, industrials, financials, consumer discretionary and materials led all sectors reporting earnings growth. Reported revenues are also higher than estimated in 86% of the reporting companies, with revenues higher by 4% than estimates compared to the five-year average of 1.2%. Year-over-year revenue growth is 20.9% led by health care, communication services, energy and financials having the largest contribution to the overall revenue increase. Analysts are expecting double digit earnings growth for the last two quarters of 2021. At 21.3 times, the forward 12-month P/E ratio is higher than the five-year average and the 10-year average, suggesting the equities continue to be extended.1
On Wednesday, the US Census Bureau reported Junes’ new construction on homes seasonally adjusted annual rate of 1.64 million against estimates of 1.59 million.2 Building permits fell to 1.60 million annual rate compared to the median forecast of 1.68 million.3 The seasonally adjusted initial jobless claims rose to 419,000 increasing 51,000 with the biggest increase coming from Michigan where auto manufacturing is shut down every summer for retooling.4 Continuing claims dropped by 1,262,815 to 12,573,833 to the lowest level since before the pandemic. 5 Unless benefits are extended, continuing claims should drop as extended Federal benefits expire in September.
Up until last week, inflation and the Fed policy response captured the interest of market participants. With the increase spread and cases of the delta variant, fears of policy reversals, returning to lockdowns and “vaccinated only” venues will give cause to further volatility in the markets. In response to government restrictions, widespread protests took place in France, Italy, the UK, and Australia over the weekend. French restrictions barring unvaccinated people from every venue is giving cause for the populations of other countries to fear the possibility of similar restrictions. If the situation continues for an extended period, re-opening could be stalled, giving market participants another worry.
In a normal environment, fear and equity volatility drives investors to the safe haven of bonds to limit potential equity losses. It could be argued we are in a monetary crisis never seen by this generation, and what historically happens is the opposite of what we would expect. With the backdrop of historic low rates, accommodative monetary and fiscal policies coupled with governments in crisis, equities are more likely than not to move higher although with more volatility than seen in recent memory.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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