(Please enjoy this updated version of my weekly commentary from the POWR Growth newsletter).
If we just looked at the S&P 500, the last 2.5 months have seemed like business as usual for this bull market. However, this misses the fact that there’s been significant churning under the surface with notable bouts of weakness in the Nasdaq and Russell 2000.
Just look at the numbers -> since 2/10, the Russell 2000 is flat, and the S&P 500 is up 8%.
As discussed in our previous commentary, this is a healthy development. The market’s rise last year and early this year was simply not sustainable. The market was overbought and over-owned. Many traders were overleveraged, and greedy speculators were bidding up stocks that had no chance of realizing their lofty valuations. [EVs, SPACs, Cannabis, Crypto, etc.]
At the same time, it was difficult to get too bearish given the strong earnings and economic outlook.
So, we’ve resolved these concerns with concentrated selling in the frothiest parts of the market, while other areas kept marching higher. Now that the market is in a much better equilibrium, I believe it’s ready to begin another move higher with wide participation across all groups.
Basically, we’re entering a new market environment that will be much friendlier to growth, small-cap, and mid-cap stocks.
This is similar to a low-intensity forest fire that makes the soil more nutritious and leads to increased sunlight for saplings. The market cleanse is a necessary ingredient for it to resume its broad-based ascent.
And, the catalysts for this move higher will be the stream of positive economic data, positive earnings surprises, and the Fed jamming its foot on the accelerator.
Let’s take it from the top…
The employment situation continues to improve with expectations of close to a million jobs added in April. Of course, this is more about the economy returning to normal as the bulk of these additions will be teachers and staff returning to schools and travel and tourism workers getting back to work.
The latter is especially important as this part of the economy has been essentially offline for most of the year. I like to monitor the TSA Checkpoint Data to get insight into where we are compared to 2019 and understand the month-to-month picture.
As we see above, we are about 50 to 60% the way back to 2019 levels. Of course, an important caveat is that international and business travel will recover much slower especially given the number of spikes in recent months.
However, the country is doing an exceptional job at vaccinating the country. An estimated 45% of the population is fully vaccinated. This, in combination with those already infected, means the country is nearing “herd immunity”. Israel may have been the first country to have reached this threshold, and cases have dramatically dropped with life mostly returning to normal.
In terms of manufacturing, we had a PMI reading above 60. This is a rare occurrence and indicates exceptional strength. Since 1960, there have been 7 readings above 60. After each one, manufacturing remained in expansion mode for another 12 months at a minimum.
Many are pointing to inflation as a threat. Certainly, there are signs of increasing inflationary pressures with some commodities at record highs and others at multiyear highs. Further, most companies have talked about “inflation” in conference calls since 2011.
There’s a vigorous debate about whether these price increases are more a reflection of supply chain and production disruptions over the last year or due to excess stimulus from the government.
While this situation will continue to be monitored. So far, it’s not having any impact in terms of profit margins.
Profit margins in Q1, so far, have been better than Q1 2020 and last quarter. These are impressive profit margins (on the high-end, historically) and indicate that inflation, at the moment, is not a serious threat to the bull market. If we start to see signs of margins eroding, then it would be a concern.
We’re in the heart of earnings season, and so far, it’s blown away all expectations. This is despite analysts having raised estimates in recent months after having badly underestimated the economy’s resilience in previous quarters.
So far, 84% of companies have beat earnings estimates, and 73% have topped revenue estimates. This means that analysts are still underestimating the strength of this recovery.
I think there’s a simple explanation – Q2 Real GDP will be around 6-8%, and Real GDP in Q3 and Q4 will be 8-10%. We simply haven’t had growth like that since the early to mid-80s. Most analysts have no experience with this type of environment.
Their assumptions and frameworks were built for a low-growth, low-inflation world. They will adjust, but it will take time. Fortunately, as students of history, we have a better understanding of what strategies and stocks will work in this type of environment.
Finally, we have the Fed. In today’s meeting, Chair Powell reiterated the current policy of zero percent rates and $120 billion in asset purchases. In his press conference, he made it clear that it’s not the time to taper or even consider tapering. In terms of inflation, he sees it as transitory and would reconsider if wage growth started to materialize.
Most notably, he pointed to slack in the labor market and containment of the virus as necessary conditions for tightening policy. The economy remains short about 8 million jobs from January 2020. There’s been significant progress in terms of combatting the virus but the Fed wants to see more declines before it’s ready to ease off its aggressive policy measures.
What I find interesting is that both goals are pretty opaque and difficult to define. The labor market is continually changing shape due to retirements, people entering the labor force, and people choosing to not work or go to school.
So pointing to labor slack as a requisite for tightening delays the decision without giving any firm timing on when the decision will be made. Similarly, saying that the “virus needs to be contained” is another loose target that gives plenty of wiggle room and no indication of timing.
Basically, I believe the Fed sees raising rates prematurely as a bigger mistake than raising rates too late. This may be residue from 2018 when it was too early in raising rates and it did so in anticipation of rising inflation.
What To Do Next?
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All the Best!
Chief Growth Strategist, StockNews
Editor, POWR Growth Newsletter
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SPY shares were trading at $417.54 per share on Thursday afternoon, up $0.14 (+0.03%). Year-to-date, SPY has gained 12.04%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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