Economic Monitor: Delta Causes Turbulence
BY: Mark Drachenberg
Normally, when a flight encounters turbulence, something outside of the airplane is the cause. That’s not the case with this Delta flight, however – the widespread variant of COVID-19 is causing strife in our society (mask mandates; less activity, like going out to eat; etc.) and could result in sustained disruption to our economy going forward.
Whether we’ll face further stress (COVID-related), self-inflict injury (via further stimulus; Fed action, or lack thereof), or finally manage to get off the “COVID treadmill” and let the economy grow on its own, without artificial means of support, remains to be seen.
Financial Markets
August picked up where July left off, and even saw some acceleration, at least as far as the markets were concerned. The Dow jumped 1.50%, the slowest rate of growth of any of the major indices. The S&P 500 doubled that by gaining 3.04%, the S&P 400 (mid-cap stocks) added 1.95% and the S&P 600 (small-cap stocks) tacked on 2.02% for the month. Even international stocks did well, as the EAFE gained 1.52%. The NASDAQ had another huge month, gaining 4.08%. Bonds were under a bit of pressure as the U.S. Aggregate Bond index fell 0.19% on the month.
The growth in stocks is being fueled, at least in part, by strong earnings. According to FactSet, S&P 500 earnings are expected to grow 42% in 2021 – significantly outpacing early-year expectations – and estimates for next year’s earnings continue to grow, too. This is helping market valuations stabilize and even shrink some, all of which is good news.
The TINA (“there is no alternative”) principle continues to hold, as stocks are seemingly the only place where one can make gains. As of now, Delta turbulence isn’t causing any problems in the markets, which is fortunate.
Economy
The threat that Delta poses to the economy is all too real, but so far, remains just that: a threat. Yes, mask mandates are popping up and some parents are opting to engage their kids in virtual learning, but overall, the economy is firing on all cylinders. In fact, manufacturing activity picked up speed in August to a level of 59.9, up from 59.5 in July (a reading above 50 indicates expansion). This good news is in spite of temporary plant shutdowns by GM, Toyota, and others, over shortages in key components. Even with the variant’s surge, inventories are so low that manufacturers will need time just to replenish shelves, not to mention keep up with demand.
Other positive news is that employers are not only looking to fill current job openings, but are also planning significant additions. Amazon is looking to hire 55,000 office and tech positions, while Walmart is planning to hire 20,000 workers. Many other companies have announced similar plans in recent weeks. The ending of added unemployment benefits and the start of the school year should boost the labor force and allow companies to find workers.
As far as workers are concerned, the increased demand for their services should cause wages to rise. Unemployment data shows the rate declining to 5.4% in July, although the rate of inflation rose to 5.37% over the past 12 months. While most continue to expect inflation to be transitory, there is a growing minority that thinks there will be some stickiness to the numbers. In fact, there is a growing expectation that the Fed could adjust its inflation target higher, to something like 3%, if it can’t push the number back down to 2%. Some think that is a good idea (for wages, higher interest rates, more flexibility for the Fed), but the question remains as to how that will happen if, prior to COVID, the Fed couldn’t even push the rate to 2%. Time will tell, but the economic data continues to be mostly positive.
Fed Watch
There was plenty of anticipation surrounding the Fed’s recent annual symposium, held virtually in Jackson Hole, Wyoming. Would the Fed announce the start of the tapering process? Would it give any indication about rates over the next year or two? Would its expectations of inflation change, or would there be nothing new? To some degree, the waffling process continued, as it did not directly state that the tapering process would start on a specific date.
Interest rates were left alone, and inflationary concerns didn’t really change. The Fed did point out the possibility of downside risk due to the Delta variant, which, should damage occur, would likely mean the Fed’s dovish stance and bond buying would continue and the tapering process would be delayed. Expectations are that the tapering announcement will now come at either the November or December Fed meetings, and likely start shortly thereafter. Obviously, this continues to be a very fluid situation.
Outlook/Summary
Once again, it’s Groundhog Day! No changes here; our outlook remains the same, with risky assets (stocks) being the asset of choice due to the TINA principle. We’re staying diversified, somewhat defensive-minded, and ready to act if it appears that the economy and markets are heading in a different-than-expected direction.
From a market perspective, we continue to stress that a correction sometime over the next six to 12 months is likely – and perhaps overdue. Getting rid of the froth is a normal condition and could be what the market needs to move substantially higher. In the meantime, look for areas where valuations may improve, such as value and international stocks, or that may provide some protection, such as floating rate bond funds. Just be prepared for the hangover, whenever it may occur.
To discuss your portfolio, or any other issue you may have, please call the Wealth Management Division of the Lake Ridge Bank at (608) 826-3570. We look forward to speaking with you.