Published on June 2nd, 2021
May 2021 | Equity Commentary
U.S. equity markets moved slightly higher in May but rising inflation concerns led to more volatility during the month. However, there is little doubt about the momentum of corporate fundamentals heading into summer. As of the end of May, nearly all of the S&P 500 companies had reported Q1 2021 earnings, with 87% posting positive earnings-per-share (EPS) surprises. That is the highest percentage beating estimates since at least 2008. European equities produced better returns than U.S. equities in May, as daily vaccination rates in Europe passed the U.S. for the first time. The ‘rolling’ global economic reopening that started with China and moved to the U.S. is now approaching Europe, which we believe bodes well for global economic growth forecasts in the quarters ahead.
Inflation took center stage as a headline risk in May, driving elevated volatility in the middle of the month, before Federal Reserve governors shared their views that inflation was likely transitory, and these comments appeared to calm markets. U.S. consumer prices jumped in April by 4.2% from a year earlier, marking the biggest 12-month increase since 2008. To be fair, April 2020 was early in the pandemic, so the base effect (comparing last year to this year) is a big reason for the steep jump. The more telling data point, in our view, is the 0.9% increase in core inflation from March to April, the biggest rise in monthly inflation since 1981.
Many readers have likely noticed signs of inflation in the economy. The national average for a gallon of gas crossed $3 a gallon for the first time since November 2014, lumber prices have more than doubled in 2021 to date, and copper prices are over 30% higher. For the first time ever, the average price paid for a used car rose above $25,000.
The housing market has also seen pronounced price pressures. The S&P CoreLogic Case-Shiller National Home Price Index jumped 13.2% from March 2020 to March 2021, which is the highest annual rate of price growth since December 2005. The U.S. Commerce Department reported that the median price of a new home sold in April was $372,400, which marked a 20.1% increase over the last year. That’s the biggest annual surge in new home prices since 1988.
Supply and demand imbalances in the housing market may ultimately correct themselves. Data over the last few months indicates that lack of inventory and higher prices are causing home sales to cool off – existing home sales have declined for three straight months and fell 2.7% from March to April. The share of consumers who said they plan to buy a house also fell to its lowest level since 2013. The pandemic catalyzed many structural changes in business and the economy, and it may have also fueled a rapid wave of migration that could abate in the coming quarters and years.
The Federal Reserve and the financial media seem to be in a tug-of-war over the inflation narrative. The Federal Reserve has been leaning into the ‘inflation as transitory’ narrative while some in the financial media have been framing long-term inflationary issues as a foregone conclusion. Both sides offer valid arguments, but investors may be better served to sidestep the debate and simply keep an eye on the 10-year U.S. Treasury Breakeven Inflation rate. This measure has seen a significant rise over the last year, but stalled in May at around 2.4%. We would attribute the pause to the rate of increase in previous months, a softening of long-term inflation expectations, and strong continued demand for government securities.
The U.S. economy continues its rapid recovery, supported by the reversion to normalized pre-pandemic activity, monetary accommodation, and fiscal stimulus. A key metric in U.S. labor markets, initial unemployment claims, fell to a new pandemic low at the end of May. Claims came in just above 400,000, better than most economists estimates and confirming a steady downward trend. Initial jobless claims are now at their lowest levels since the pandemic’s onset. Consumer confidence also remains on a upward trend, and while it has yet to reach pre-pandemic levels, appears poised to do so perhaps later this year.
Internationally, Europe appears to be turning a corner on the pandemic, with 30% of adults now vaccinated compared to about 50% in the U.S. Europe reached a new milestone in May, however, surpassing the U.S. in daily doses administered. As the E.U. emerges from recession and joins the U.S. and China in its return to growth, we expect the global economy to gain momentum as the year progresses. Overall, while we continue to keep a watchful eye on the risks posed by rising interest rates and inflation, we still believe the most prudent course for equity market participants is to remain broadly invested to capture the benefits of global reopening.
As of May 31, 2021