Is the Summer Rally Just Getting Underway?
U.S. stocks rose on Friday with the S&P 500 building on its rally to records, as investors bet that higher inflation will be temporary as the economy continues to recover from the pandemic.
The broad equity benchmark climbed 0.3% to hit another closing record high of 4,280.70. Financials were the best-performing S&P 500 sector with a 1.3% gain. The Dow Jones Industrial Average rose 237.02 points, or 0.7%, to 34,433.84, sitting less than 2% from its record. The Nasdaq Composite erased earlier gains and closed 0.1% lower at 14,360.39 amid a rise in bond yields. The 10-year Treasury yield jumped 4 basis points to 1.52%.
The S&P 500 rallied 2.7% for the week, notching its biggest weekly gain since early February. The Dow gained 3.4% this week for its best week since mid-March, while the Nasdaq advanced 2.4%.
Friday’s rally came after a key inflation indicator that the Federal Reserve uses to set policy rose 3.4% in May, the fastest increase since the early 1990s, the Commerce Department reported Friday. The reading matched the expectation from economists polled by Dow Jones. The core index rose 0.5% for the month, which actually was below the 0.6% estimate.
The core personal consumption expenditures price index increase reflects the rapid pace of economic expansion and resulting price pressures, and amplified how far the nation has come since the pandemic-induced shutdown of 2020.
“This provided support to the Fed’s argument that inflation is transitory and will help allay fears that we are witnessing runaway inflation,” said Anu Gaggar, senior global Investment analyst at Commonwealth Financial Network. “This should continue to provide support to risk assets such as equities.”
Bank shares jumped after the Federal Reserve announced the banking industry could easily withstand a severe recession. The Fed, in releasing the results of its annual stress test, said the 23 institutions in the 2021 exam remained “well above” minimum required capital levels during a hypothetical economic downturn. The decision cleared the way for the banks to raise dividends and buy back more stock, which was suspended during the pandemic.
Wells Fargo climbed 2.6%, while Fifth Third and PNC all gained over 2%. JPMorgan and Bank of America both rose more than 1%.
Nike’s stock surged 15.5%, helping to boost sentiment for the Dow. The company reported earnings and revenue that blew past Wall Street estimates. Digital sales also jumped 41% since last year and 147% from two years ago.
On the flipside, FedEx dipped 3.6% despite beating on the top and bottom lines of its earnings. FedEx also gave a strong yearly outlook.
Friday saw heightened trading volume as FTSE Russell was set to rebalance its U.S. stock indexes at the market close. Bank of America estimated that more than $170 billion worth of shares would be changed hands as a result of 625 changes in total to Russell indexes, including the Russell 1000 and Russell 2000.
President Joe Biden announced Thursday that the White House struck an infrastructure deal with a bipartisan group of senators. The lawmakers have worked for weeks to craft a roughly $1 trillion package that could get through Congress with support from both parties. The framework will include $579 billion in new spending on transportation like roads, bridges and rail, electric vehicle infrastructure and electric transit, among other things.
The stock market came back from last week’s swoon induced by worries about a tighter Federal Reserve. Last week, the Dow fell 3.5% and the S&P 500 shed 1.9% as the Fed moved up its timeline for interest-rate increases.
What a difference a week makes in these volatile markets.
Last week, people were worried about a whiff of hawkishness after St. Louis Fed President James Bullard dropped a bomb, hinting the Fed would have to taper sooner than expected to "contain inflationary pressures."
That hit cyclical share very hard last week but this week, they rebounded nicely led by gains in Energy (XLE), Financials (XLF) and Industrials (XLI):
Two big announcements helped cyclical sectors this week:
- President Joe Biden declared Thursday that the White House has struck an infrastructure deal with a bipartisan group of senators after discussing the massive plan to improve the nation’s roads, bridges and broadband earlier in the day.
- The Federal Reserve on Thursday said it will lift COVID-era dividend and share buyback restrictions on the largest banks, potentially setting up big bank shareholders for a windfall of capital distributions.
It also helped that Nike shares (NKE) closed Friday up more than 15%, hitting a record intraday high, after the sneaker maker forecast full-year sales topping $50 billion as its North American business rebounds from the lows of the coronavirus pandemic.
While all these announcements are bullish, there was something else driving risk assets higher this week, the Fed's expanding balance sheet:
#Fed extends balance sheet expansion beyond the $8tn mark. Total assets rose by another $37.7bn past week to hit fresh ATH at $8.102tn as Powell keeps printing press rumbling. Fed balance sheet now equal to 37% of US's GDP vs #ECB's 78%, #BoJ's 134% or #SNB's 145%. pic.twitter.com/UGXYmgYU06— Holger Zschaepitz (@Schuldensuehner) June 25, 2021
Incidentally: The Fed's balance sheet has increased by $150B in size in just the past 2 weeks, more than twice the pace of the supposed monthly $120B QE asset purchase program. pic.twitter.com/qygZHuqM80— Sven Henrich (@NorthmanTrader) June 25, 2021
It's not just the Fed, the European Central Bank (ECB) and Bank of Japan (BoJ) are also pumping trillions into markets and all that liquidity is driving stock sand other risk assets higher.
Some big economists are taking note and worrying about the Fed's interventionist ways.
John B. Taylor, professor of economics at Stanford University and a senior fellow at the Hoover Institution, wrote a comment today asking whether the Fed is getting burned again.
Take the time to read his comment here but this is how he ends it:
The message from this historical experience – and many other examples in the United States and elsewhere – should be abundantly clear. And while history never repeats itself, it often rhymes, so consider where we are midway through 2021: inflation is picking up, and the Fed is once again claiming that it is not responsible for that development. Instead, Fed officials argue that today’s surge in prices merely reflects the bounce back from the low inflation of the last year.
Worse, the Fed’s policy is even more interventionist now than it was in Burns’s day. Its balance sheet has exploded from massive purchases of Treasury bonds and mortgage-backed securities, and the growth rate of M2 has risen sharply over the past year. The federal funds interest rate is now lower than virtually any tested monetary policy rule or strategy suggests it should be, including those listed on page 48 of the Fed’s own February 2021 Monetary Policy Report.
It is not too late to learn from past mistakes and turn monetary policy into the handmaiden of a sustained recovery from the pandemic. But time is running out.
Fed officials don't seem too concerned about inflation:
Nor is there much concern about the reverse repo volume which hit a record $813.57 billion on Thursday:
U.S. Fed reverse repo volume hits record $813.57 bln https://t.co/TgAEcDVUDn— Leo Kolivakis (@PensionPulse) June 25, 2021
Whether or not the Fed tapers sooner than expected remains to be seen but some are already sounding the alarm that global economic growth is peaking here.
In his latest weekly wrap-up looking at whether a summer rally is underway, Martin Roberge of Cannacord Genuity states this:
As we reported Wednesday, the marked drop in the OECD LEI diffusion index earlier this spring signalled a shift from the expansion to the slowdown phase of the economic cycle. This means that a peak in the rate of growth of economic activity has likely arrived and manufacturing PMIs worldwide are nearing peak levels. In fact, the relative MoM flatness in flash PMIs released this week in the US, Eurozone and Japan seems to validate the notion of peak growth. While we have shown in prior wires that peak economic activity usually coincides with peak profit margins and earnings revisions, our Chart of the Week suggests that the bond yield curve could be a peak levels as well. While it is already down from a high of 160bps seen in late March, at 125bps today, odds are that the US 10y-2y curve is likely to drop to 100bps rather than rise to 150bps over the next several months. Accordingly, since banks are among the sectors most sensitive to the yield curve, this suggests that this week’s rally in relative performance may not be sustainable. In fact, history shows that through the slowdown phase, the tug-of-war between the two value mammoths, that is energy and financials, is usually won by the former. We will offer more color on our market and sector views in our upcoming Mid-Year Update.
If Martin is right, it's time to go Long Energy (XLE)/ Short Financials.
Or better yet, just go long the Nasdaq (QQQ) as rates drop and global growth slows.
Interestingly, I noticed a few things going on in the market over the past month.
First, Cathie Wood's ARK Innovation ETF (ARKK) has come back strong as hyper growth stocks like Docusign (DOCU) and Tesla shares rallied sharply:
Why aren't these stocks crashing already? Simple, there's too much liquidity and there's a fear that low growth and low rates are here to stay, so investors are hopping right back into hyper growth and concept stocks.
On the other hand, the meme stock mania led by shares of AMC Entertainment (AMC) seems to be petering out but it remains to be seen whether speculators will ramp it up again:
It's a very weird market, there's no real conviction but there are definitely some huge moves happening, like shares of Virgin Galactic (SPCE) rocketing up after the FAA approval to fly passengers to space.
Anyway, I think it's safe to say, the Fed's (Dot) Plot is lost in this environment:
.@MohammedNalla explains the Fed’s 'Dot Plot', an expression of how the 12 FOMC members and 6 regional Fed bank presidents view policy rates over the next 3 years and beyond; and how they tend to overshoot, only to pull back in line with market realities. https://t.co/eoxB59pk2M— finweek (@finweek) June 25, 2021
Worse still, some fear the Fed is trapped in an epic bubble and it can never normalize rates again:
Albert Edwards: The Fed Is Trapped In An Epic Bubble, It Can Never Normalize Rates Again https://t.co/Ou9bulXXNx— Leo Kolivakis (@PensionPulse) June 24, 2021
Fun times but keep watching the Fed's balance sheet and that of other central banks, the rest seems immaterial in this environment.
Below, CNBC's "Halftime Report" team discusses markets and their outlook.
And Ray Dalio, founder and co-chief investment officer at Bridgewater Associates, says he doesn’t believe the Federal Reserve can tighten policy "without a big negative effect" on markets. "You saw the reaction in the markets when the Fed just even hinted at tightening," Dalio said at the Qatar Economic Forum Monday.