August 2021 | Equity Commentary
Published on September 8th, 2021
The S&P 500 index rose about 3% in August, marking its seventh consecutive monthly increase. Year to date through August, the index made 53 new all-time highs—the most recorded since 1964. Since the March 2020 lows, the S&P 500 has more than doubled1, charting a “v-shaped” recovery often characteristic of event-driven bear markets. Ten- and 30-year U.S. Treasury bond yields remained relatively unchanged in August, which appeared to complement decelerating inflationary pressures and a still-dovish Federal Reserve.
Stocks’ summer rally coincided with a robust earnings season. A Wall Street Journal analysis found that more than 75% of U.S. companies reported higher revenues in Q2 2021 than Q2 20192, which offers insight into corporations’ ability to resume pre-pandemic growth trends. FactSet data from mid-August showed that of the 91% of reporting S&P 500 companies, a staggering 87% of them had delivered positive earnings-per-share and revenue surprises for the quarter.3
The U.S. economy continues expanding, but we believe there are a few signs growth may be cooling slightly. In August, factories and service providers – as measured by the IHS Markit surveys of purchasing managers – saw activity dip. On the service-sector side, the purchasing managers index fell to an 8-month low of 55.2, while the manufacturing index sank to a 4-month low of 61.2.4 These declines are noteworthy, though it’s worth recalling readings above 50.0 signal expansion. The economy appears to be still growing, just at a slower pace.
The Federal Reserve held its annual Jackson Hole symposium virtually for the second consecutive year. As ever, investors parsed Chairman Jerome Powell’s speech for clues regarding when, and how quickly, the Federal Reserve may begin tapering bond purchases and/or raising interest rates. Though opinions vary among FOMC members, Chairman Powell continues to tilt dovish and appears committed to moving slowly. Many market participants continue to link tapering with rate increases, but Chairman Powell has attempted to disassociate the two. His statements suggest tapering need not directly signal an impending rate hike in 2022.
Chairman Powell also seems less concerned about a tight labor market driving inflationary wage pressure than some of his more hawkish counterparts, who cite employers’ ongoing challenges finding workers. Though the Federal Reserve has no parameters defining ‘full employment,’ Chairman Powell seems fixated on employment being ~6 million jobs below its February 2020 level, with stubborn levels of slack in the services sector. He sees a low likelihood of a persistent wage-price spiral.
The Federal Reserve remains similarly dovish on inflation as it believes Covid-related supply chain disruptions are driving relatively narrow price gains—a view supported by longer-term inflation expectations, which remain relatively moderate. Chairman Powell has clearly stated his belief it would be a mistake for the Federal Reserved to respond to what it views as temporary price fluctuations, which makes interest rate increases very unlikely in 2021.
On the political front, the House of Representatives inched closer to passing Democrats’ economic centerpieces before adjourning for its August recess. A 220-212 party-line vote approved a $3.5 trillion budget framework (the American Families Plan) and advanced the $1.0 trillion infrastructure bill. The Senate already passed the budget framework, allowing House and Senate Democrats to craft a budget without Republican involvement (budget reconciliation only requires simple majorities in both chambers).
In exchange for moderate Democrats’ support for the reconciliation bill, Speaker Pelosi has committed to a vote on the infrastructure bill by September 27. As ever, the devil will be in the details, many of which are still missing and will likely prompt sharp debate among the various factions in the Democratic Party. Further complicating the legislative schedule is the impending debt ceiling, which the U.S. government may reach in September or October. All told, increased spending—which seems likely under most legislative scenarios—should provide a modest fiscal tailwind in future quarters.
Surging Covid-19 (Delta variant) cases in the U.S. have shown signs of weighing on consumer sentiment. The Conference Board’s consumer confidence index fell from 125.1 in July to 113.8 in August, pulling the index back to February 2021’s level (before the vaccine was widely available). Consumer spending growth in July was up just 0.3% from June levels—a considerable deceleration from May to June’s 1.1% growth.5 Some states and businesses have responded to rising cases by reintroducing indoor mask mandates and/or requiring proof of vaccination, and event cancellations and delays are becoming more common. Several high-profile corporations have also delayed office reopening plans.
August offers a single data point for consumer sentiment, and it’s worth noting sentiment data tend to be backward-looking. It does not offer much insight into where the economy may be headed, particularly if Delta ebbs as quickly as it has in countries like India and the U.K. Fading pandemic risk could unleash some additional spending as consumers return to more normal economic activity. We believe the odds favor a peak in new cases over the next 3-6 weeks, although students returning to the classroom could also spur a rise in new cases. Ongoing fiscal stimulus is also bolstering the economy in the near term, as child tax credit starting hitting accounts in July. Fiscal stimulus contributed to a 1.1% July increase in household income (according to the U.S. Commerce Department), marking the biggest jump since March 2021.
Globally, rising cases—particularly in Southeast Asia—are disrupting production and prolonging supply chain issues. Malaysia, an important if underappreciated link in the semiconductor supply chain, has struggled with a recent surge in cases, prompting staff shortages and introducing yet another hiccup in semiconductor production. China’s economy is also showing signs of ongoing Covid-related strains: that country’s services sector purchasing managers index (PMI) contracted in August for the first time since February 2020, while manufacturing PMI barely eked out a positive reading (50.1), with the new orders sub-index modestly contracting (49.6).6
Finally, the geopolitical situation in Afghanistan reached a climax in late August with the full U.S. troop withdrawal. The market effect appeared negligible, despite the tragic loss of life. The tail risk in the U.S. revolves around domestic policy—e.g., if the Afghanistan unraveling were to disrupt the Biden administration’s pursuit of other economic policy objectives, like the aforementioned spending packages.