Markets rebounded from mid-week lows to finish the week higher with growth, large-cap, and interest-sensitive stocks providing leadership outperforming small-caps and energy. Mid-cap and small-cap indices finished the week in negative territory. Over the last several weeks, investors reacted positively to falling rates as analysts adjust forecasts, lowering discount rates on future earnings and making equities more attractive. Mid-week investor sentiment reversed course over concerns about lower rates signaling slowing growth. On Friday, S&P and Dow large-cap indices rebounded to new highs.
European shares followed the same pattern as their North American counterparties gaining ground at the first of the week only to retreat on Thursday and recover on Friday to finish the week fractionally higher. Concerns that an increase in the highly contagious Delta strain of coronavirus and weak US services data might stall the recovery, pushing investors into high-quality bonds. As in North America, bonds rates fell in reaction to increased demand.
In Asia, the Japanese equity market responded negatively (losing 2.93% on the Nikkei 225 Index and the broader-based TOPX down 2.25%) to the government’s decision to place Tokyo under a coronavirus state of emergency until August 22. Worries that the Olympics could further spread an already increasing virus caseload triggered the government’s decision. The Chinese equity markets finished the week mixed on the announcement that the People’s Bank of China would reduce the reserve requirement ratio, the amount banks must hold in reserve at the central bank. The reduction in the reserve requirement is seen as a way to shift credit (about 1 trillion RMB of long-term liquidity), providing additional support to struggling small and medium-sized businesses. In contrast to the West, Chinese economists see indications the recovery is fading, resulting in the policy shift. 1
On Tuesday, the Institute for Supply Management (ISM) released its latest survey for service-related businesses. The survey fell to 60.1% from May’s survey reading of 64%, not from a lack of demand but rather the lack of supplies and continuing labor shortages. A reading above 50 indicates expansion, and a reading above 60 is considered extraordinary, but it should be remembered the recovery is coming from a previously unfathomable self-inflicted low.2 A survey of manufacturing activity also reported a lagging indication sliding to 60.2% from 61.2% in May for the same reasons, lack of supplies and labor shortages. With order books near 17-year highs, the inability to meet demand is forcing businesses to automate where possible. A production survey increased to 60.8%, but that is reportedly hardly keeping up with new orders. Higher prices for supplies and transportation issues are forcing manufacturers to pass along price increases causing inflationary pressures thought to be transitory by the Fed.3 The Bureau of Labor Statistics reported on Wednesday that nonfarm payrolls added 850,000 new jobs in June, primarily in leisure and hospitality, public and private education, professional and business services, retail trade, and other services. Job quitters, those who left to seek better or higher-paying employment, increased by 164,000 to 924,000.4 Initial jobless claims increased to 373,000 compared to a survey of economists forecast of 350,000. Continuing claims dropped 449,000 to 14,209,007 from the previous week.5
While the economy is surging ahead, the common theme to limiting full recovery is material and labor shortages. Labor shortages are being attributed to early retirements, taking advantage of rising real estate prices and higher valuations of stock portfolios, lack of childcare, and fear of coronavirus, especially the new Delta variant. Additionally, some would add the federal supplemental benefits, due to expire in September, making it more attractive for some to stay at home rather than seek employment. However, it could be argued the most significant risk to both equity and bond markets currently is inflation data. If inflation continues to be running hot over the next several months, a Fed response is most likely later this summer, causing market volatility impacting equities and bonds.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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