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Market Snapshot

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LIZ ANN SONDERS:  Hi, everybody. Welcome to the June Market Snapshot. What I want to do this month is actually a video version of my mid-year outlook piece, which was posted on last week. I know there’s people that are more visually oriented, they like the video version, but, certainly, as I go through some of this stuff quickly, if you want more detail, if you want to see that commentary, you can check out that report online. So I want to start big picture, look at economic data, tie it into the market toward the end.

So I want to start with not really a measure of economic growth in an absolute sense, but a measure of how economic data is coming in relative to expectations. And that’s picked up by fairly well-watched indices that Citi puts out. It’s the Citi Economic Surprise Index. They actually have them for many countries, many regions. In this case, it’s for the United States, specifically. And it just measures how economic data is being reported relative to whatever the consensus expectation is. So when you see a falling line down into low territory like you saw during the worst part of the pandemic last year, you can see that big drop, that was a period where economic data was significantly underperforming relative to expectations. Then we had the reopening, and we saw because the expectations bar was set so low, data started coming in much better than expectations. And you see that in that parabolic increase to a level we have never seen in the history of this data. Since which point we’ve been settling back down, and we sit right now just about on the zero line.

And you can see, essentially, three bands denoted here with those yellow dotted lines, that narrow neutral kind of right around zero band that you see we’re in right now, and then the stronger band above that, and the weaker band below that. And what the table down below shows, and maybe no surprise, is that when you’re in that environment where economic data is significantly better than expectations. That’s when you’ve gotten, historically, the double-digit annualized returns for the S&P. But as you start to move down into that neutral and then lower zone, that’s when you start to see some deterioration in the data. So it’s just something we need to be mindful of. It’s not to say that we won’t bounce back up and move into the higher zones, but this is something to watch.

Now, part of the reason for the extreme moves we have seen in an index like that is the nature of stimulus associated with this crisis, with the pandemic. Unlike the financial crisis, when stimulus was largely focused on the monetary side, this time, it has been both monetary and fiscal stimulus, kind of double-barreled stimulus. That had the effect of boosting M2 money supply up to a recent peak of 27% year-over-year growth. We haven’t seen anything like that, certainly, in this time period. If you look at money supply proxies prior to this, you would have to go all the way back to the World War II period to see that kind of growth. You also now see that that’s come down quite a bit, from about 27% to about 18%. That’s not because of the withdrawal yet of monetary stimulus. That’s still to come. But the fact that most of the direct stimulus on the fiscal side is largely in the rear-view mirror, and that has started to descend.

What’s key to watch for a variety of reasons, not least being inflation, is that yellow line, which is the velocity of money, the M2 velocity. It measures whether all that money that has been pumped into the system—financial system, households, businesses—is actually going out and sort of going to work in the economy, and that’s the concept of velocity. And you can see that remains very low. It seems to be stabilizing. You, generally, don’t get a sustainable, serious inflation problem unless you see that pickup in velocity. So keep that on your kind of, you know, radar screen as we move out of this near-term focus on inflation and try to get a sense of what the path in the future looks like.

Another factor driving inflation, both near-term and something to be mindful of longer-term, is just, broadly, the labor market, slack in the labor market, and, more specifically, wage growth. And there’s lots of ways to measure slack in the labor market. If we do simply look at payroll jobs, we’re still almost 8 million payroll jobs shy of where we were pre-pandemic. That metric would suggest a lot of slack, still, in the labor market part of the economy. Here is a metric, though. This is small business hiring plans that is way off the chart, and suggests that even if we officially still have slack in the labor market, there are parts of the labor market that are much tighter than some of those metrics would suggest. This tends to be a precursor to a bigger jump in wages.

Now, there’s lots of ways to look at wage growth. I’m showing two here. The blue line is average hourly earnings. It’s a measure of wage growth that gets reported once a month at the same time we get the monthly jobs report. As a result, it tends to be well watched. It’s fairly popular. It’s a common labor market metric. The problem with this metric is it’s a simple average, and that helps to explain why you saw the extreme move up last spring, and now a similarly extreme move down. The reason for that is last spring… and that peak at 8% wage growth was in April of last year. That was the month where we actually had a loss of more than 20 million jobs. That seems quite odd that we would be having very, very strong wage growth at that same period of time. We weren’t. What was happening is that most of the job losses were concentrated in the lower wage end of the spectrum—leisure, hospitality, restaurant workers. So what happens when you take a bunch of low numbers out of an average? It biases the average up. Well, the complete opposite has been happening more recently, where many of the job gains have been concentrated in those low wage areas. keeping that average down.

That’s why, whether it’s median measures of wage growth that are probably more appropriate to look at, or a metric that has always been widely watched by economists, by the Fed, is the Employment Cost Index. This, in essence, is a medium wage measure. It’s a broader measure. It does not get biased by the mix shifts, if you want to call it that, that can kind of wreak havoc with a simple average. So this is the wage metric that I would keep a close eye on. We’re seeing a little bit of an upturn, but a more sustainable upturn, I think, would change the landscape in terms of transitory inflation or something maybe longer lasting or a bit more sinister than that.

In the meantime, though, we’re all dealing with the effects of this inflation that we’re seeing, not least being companies, themselves. So there’s two common inflation metrics, PPI and CPI, Producer Price Index, Consumer Price Index. The Producer Price Index basically measures input costs that businesses are facing. And then the Consumer Price Index is sort of the end game, ultimately, what costs are passed on to the consumer. And the chart here is the difference between the two. So it’s CPI minus PPI. And when like now, the spread is very wide and in negative territory, it means that input costs for companies are significantly higher than, ultimately, the price increases that we’re seeing at the consumer level. And that puts a constraint on companies and really puts it in a position either to eat this spread in their profit margins or make the decision to try to pass those higher costs on. So it could mean that we start to see an even bigger acceleration in the Consumer Price Index if companies continue to pass it on, but if they opt not to or they don’t feel they have the ability to do it, then we have a potential weaker profit margin story.

But if you look down below and you look at three scenarios here for this spread—a negative spread, which currently we’re in right now; no spread at all, where basically you have PPI and CPI in line with one another; and then a positive spread where actually input costs are lower than consumer costs. And you can see the subsequent six month performance for the S&P and one-year, or 12-month, performance for the S&P. And maybe, no surprise, the market has had historically weaker performance when you’re in a negative spread territory—not dire negative type returns, but clearly weaker than when the spread is in the opposite direction. So another thing to keep an eye on with regard to inflation.

Switching over, though, to some good news associated with the upturn here is that earnings have absolutely soared. This is the change in earnings from one year after the recession low compared to whatever the prior cycle high was. And you can see that the current experience or expected experience given consensus estimates for earnings this year is well stronger than anything we have seen in the past. In fact, historically, at this point in the post recession cycle, only 1960 were we back in positive territory from an earnings growth perspective. Typically, it takes a lot longer to go back into positive territory. Very different this time, much more of a condensed cycle.

And this improvement in earnings as part of the reason why the P/E ratio for the S&P 500 has actually come down quite a bit since the lofty levels of late last year, not to a level that is suggestive at all of a cheap market. Don’t get me wrong. The market is still expensive. But toward the end of last year, we were looking at a P/E on the S&P of around 27. As you can see on the chart with the blue line, that’s right around the levels where we were in the late ‘90 into the peak in 2000. The important difference, though, is if you look back at that 2000 era, earnings were rising at the same time. In fact, they were rising into a peak that actually occurred a few months after the peak in the stock market. Very different scenario this time. You can see that the surge in the P/E ratio came by virtue of the plunge in the E. So you had the plunge in the denominator bringing the ratio up.

Now, we have the opposite. We’ve got a surging denominator. And what the dotted line show, all else equal, which is a silly thing to say when it comes to the stock market because things are always changing, but just for illustrative purposes, the estimates for earnings are shown in the yellow dotted line and then all else equal, no other changes, that’s what would happen to the P/E ratio if earnings pan out as expected. So at least we’re an environment where earnings are doing a bit more of the market’s heavy lifting, so to speak.

I want to now talk a little bit about sentiment. And some of the success of the market in the earnings story has driven margin debt levels into the stratosphere, as you see on the left-hand side. Now, I will tell you that I find, at times, people who show this margin debt chart, in and of itself, without any reference point, without anything in rate of change or relative terms, may not be sending the appropriate message, because margin debt, even when it’s soaring, if its growth rate is in line with the growth rate in terms of appreciation in the stock market, it’s not necessarily a warning sign. However, if you do look at the rate of growth, and this is a 15-month rate of change, because we wanted to capture, basically, the full pandemic, post-pandemic periods since March of last year, and that rate of growth, at almost 80%, is not out of line relative to what the market has done.

However, we need to be mindful of when that starts to peak and move down. That is what’s referenced in the table below. So if you think just with the terminology of buy signals and sell signals, this is not a trading model, this is terminology that Ned Davis Research who put the static together opted to use. This is not a trading recommendation on my part. We’re calling them buy signals and sell signals. The buy signals would be at the bottom, where margin debt has plunged, hits a bottom and starts to move back up. The sell signal is the opposite. These peaks that you have seen, historically, well above that yellow dotted line, at the point, they peak and start to move down, those would be considered the so-called sell signals. So the table shows after those signals three, six, nine, 12, 18 months later how the market has performed. And you can see that after peaks in margin and it starts to move down, you’re actually in negative territory in every instance for the three out to 18 months after. Not terribly weak numbers, but negative throughout.  Conversely, after these so-called buy signals, when margin debt plunge and starts to move up, that’s when you get the really, really powerful gains in the stock market. And then for general reference, that final column is just all three-, six-, nine-, 12-, 18-month periods. So you can just put it in relative terms. So really key to watch if we start to see margin debt rollover. If history is any guide that might suggest a choppier period for the market.

Another maybe slightly different sentiment indicator than the traditional ones I might show is one that isn’t really about investor sentiment, but about corporate sentiment. So this is a fairly well watched CEO confidence measure. And you can see, that as absolutely off the charts. We didn’t actually bottom to the same negative degree as, say, the global financial crisis, but the rebound has taken this index into uncharted territory based on history. Now, in theory, this would seem like a really positive stock market indicator. CEOs, they understand their business. They’re probably reacting to strong earnings. The rub is that the stock market as a leading indicator, as a discounting mechanism, tends to have had a lot of its improvement along this path of improving CEO confidence.

And that’s why as you see below, the higher zone of CEO confidence has been accompanied by the weaker performance by the stock market. Conversely, when you’re in the weaker zone for CEO confidence, the market has done better. Again, reflecting that once you get to these heights of confidence and earnings growth, typically, the market has priced a lot of that in already.

So I just wanted to give that flavor of the economic data, the market data, and try to connect the dots between the two, and make sure that people know that as you get to this point in the cycle what is very, very strong economic news in level terms can sometimes start to cause some volatility in the market if the market has largely already priced in some of that economic or earnings success. 

So I hope you enjoyed the video. Take a lot at the written report for more detail. And, as always, thanks for tuning in.

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