By Justin Pawl, CFA, CAIA, CFP®
Some things are bigger than markets and more important than “making money.” Last week’s bombing in Kabul took the lives of 13 American heroes and countless innocent Afghanis. Regardless of your political affiliation, opinions about the war in Afghanistan, or our withdrawal from the war, it’s worth keeping in mind that our frontline military men and women take orders from someone and don’t have a say in where they go or the situations in which they’re thrust. Yet, these heroes, all of whom are volunteers, go selflessly because they place their love of Country above their safety. May God bless the souls of those who lost their lives and comfort the families left behind. To any current or retired members of the military and their family members who happen to read this, thank you, thank you, thank you for your service.
Last Week Today.
- Janet Yellen (former Chair of the Fed and current Secretary of the Treasury) endorsed reappointing current Fed Chair Jay Powell. Yellen’s support is a strong indication that Powell will remain Fed Chair when his term ends in Feb 2022, when the Fed will presumably be tapering its bond purchase program.
- The August IHS Markit PMI services index fell from 59.9 to 55.2, while the manufacturing index declined from 63.4 to 61.2. While high on an absolute basis, both surveys are at eight-month lows, reflecting the Delta variant’s early impact. If the hard economic data catches down to the survey data, some more hawkish Fed officials may change their tune about removing accommodation until they better understand Delta’s economic impact.
- At the much-anticipated Jackson Hole event, Fed Chair Powell didn’t offer anything new regarding the Fed’s monetary policy plans. However, after numerous hawkish comments from other members of the FOMC leading up to the event, Powell’s keynote speech underscored that the Fed would not hike rates for a long time. The dovish comments relieved investors’ rate-angst, and equity markets hit new highs.
- The Fed’s favored measure of inflation, Personal Consumption Expenditures (PCE), was revised modestly higher for May and June. However, PCE for July, was in line with expectations. On balance, this reflects continued pricing pressure but no acceleration.
- Covenant’s Investment Committee met last week. My partner Karl Eggerss and I recap findings from the meeting in this week’s “Creating Richer Lives” podcast.
Friday’s record close was the S&P 500’s 52nd of the year, and the index crossed over 4,500 for the first time. The Russell 2000 Index rose 3% on Friday and 5% for the week, which may be an early indication that the market is sniffing out a peak to Covid cases and a rebirth of the “re-opening trade.” Developed international stocks modestly outpaced their U.S. counterparts, while emerging markets staged a recovery after a tough run and bounced 4.3%. Treasury yields at the long end of the curve rose ~0.05% (though the 30-year bond yield remains below 2%), but at the short end, rates declined following the dovish remarks at Jackson Hole. The commodity index was broadly higher, with WTI Crude (+10.3%) and Natural Gas (+13.5%) the standout performers as Gulf Coast oil production was all but shuttered in advance of Hurricane Ida. For asset class performance details, click on the table below.
Delta Peak? Some current data points suggest that daily Covid-19 (and its variants) infections may have peaked. If the current trends continue, it would be a bit of sorely needed good news on the Covid front. The first data point is provided by the Institute for Health Metrics and Evaluation. IHME is a research institute at the University of Washington at Seattle working in global health statistics and impact evaluation. The institute was founded in 2007 with a core grant of $105 million, primarily funded by the Bill & Melinda Gates Foundation. Covid infection and mortality models developed by the organization in 2020 reportedly informed pandemic guidelines developed by the government. However, it’s worth noting that many in the epidemiological community criticized the models as overly optimistic. Setting that criticism aside for a moment, the IHME’s models suggest that daily Covid-19 infections have declined slightly from their peak ten days ago and are expected to continue falling.
Even if the IHME’s models prove overly optimistic, the more problematic issue of hospital capacity appears to be waning. While there are about 93,000 people hospitalized due to Covid, the rate of change in hospitalizations is rapidly declining. This lends further credence that the U.S. is past peak infections.
And, the 7-day average of positive tests has rolled over.
It’s too early to declare victory against Delta, but there are early signs that the worst of it may be behind us. Having said that, it will be a long time before we defeat Covid. It’s more likely that we will need to learn to co-exist with the virus just as we do with influenza (aka, the flu). Covid is proving a master mutator, and it will be an arms race between scientists and Covid to develop vaccines to combat future variants. We need to accept that extinguishing the virus is a long way off. The upside is that science offers an opportunity for future variants to cause fewer interruptions in our lives.
Curb Your Enthusiasm. Despite record stock levels, robust corporate earnings, and a booming economy, investors are less than enthusiastic. It’s difficult to pin down exactly why investor sentiment is subdued, but one could point to the situation in Afghanistan, inflationary pressures, and, of course, the ongoing battle with Covid. Yet, as often happens, domestic stock markets surmounted all of these factors and pushed to new highs. In Wall Street parlance, the market is climbing “the wall of worry.”
For example, the CNN Fear & Greed Index is registering a Neutral reading. This index incorporates data from seven sources, including Junk Bond Demand, Market Momentum, and Market Volatility. As the chart highlights, sentiment was extremely positive before the pandemic but turned deeply pessimistic at the end of the first quarter when Covid came on the scene and markets plummeted. Sentiment indicators are often a contrarian indicator for the future direction of the stock market. When investors are overly optimistic, future returns tend to be below average and vice-versa.
Sources: CNN and Covenant Investment Research.
While CNN’s Fear & Greed Index is neutral, Goldman Sachs’s Sentiment Indicator turned negative and just hit the lowest level in more than a year. I point this out because not only does the chart below illustrate how rare a negative print has been in the last year, but because higher S&P 500 returns often follow periods of negative sentiment. The green line is the rolling 4-week S&P 500 return (right axis), and the bars show the level of Goldman’s equity sentiment indicator. Though not at the extreme negative sentiment levels witnessed during the lockdown, the indicator is at its lowest point in 63 weeks tracing back to May 2020 when we were in the throes of the initial Covid-19 lockdown. For context, in March of this year, the sentiment indicator ranked in the 98th percentile (based on a 10-year lookback) but has now fallen to the 34th percentile. In other words, the indicator is low not just by the standard of the last fourteen months but based on the previous 120 months.
Source: Goldman Sachs and Covenant Investment Research.
Bottom Line: A lack of optimism leaves room for good news (whether it’s related to the economy, the virus, or geopolitics) to have a more pronounced impact on further market gains. The lack of extreme optimism can also buffer downside market risks since it indicates investors are not positioned in a manner requiring exposure cuts in the face of bad news. Please note that the lack of broad investor enthusiasm is not a green light to load up on risky assets. It’s only one of many market indicators, and portfolio changes should be made in conjunction with sound financial advice and consideration of your specific financial plan.