Paulsen's Perspective
Bonds Race The Stock Cars!
Since 2008, the “direction” of the 10-year bond yield has been highly correlated with stock market leadership. Although the level and direction of yields have always been significant factors for stock investors, their role has seemingly become much more pronounced, since 2008, relative to earlier years. That is, since the Great Financial Crisis, the bond market has been determining, or at least coincidently signaling, which stock cars will be the winners and the losers.
Tapering Has Already Begun!
Many worry what will happen when the Federal Reserve finally begins tapering? Quit worrying. Tapering has been happening for the last three months!
A Capital Spending Cycle?
For the first time in more than 20 years, U.S. capital spending has broken to new record highs and seems poised to remain robust for some time. As shown in Chart 1, core capital goods spending (i.e., non-defense capital goods orders, excluding aircraft) stalled after its early 2000 dot-com peak and was stuck in a broad sideways range until late 2020. Over the last year, though, capital goods spending has surged by 25.2%, its biggest twelve-month jump since early 1993!
How “Out Of Whack” Is The 10-Year Bond Yield
The 10-year Treasury yield is 1.58%, flat with the level it initially spiked to in late February and down from its late-March recovery high near 1.77%. The inflation rate is running far above the 10-year yield, and so is the 10-year breakeven rate. U.S. commodity prices have surged 75% in the last year, and the Atlanta Fed’s GDPNow estimate of current quarter real-GDP growth is a red-hot 10.1%.
An Arbitrary Assortment
Just a handful of arbitrary thoughts to start the week…
“How Low” Could Credit Spreads Go?
Everyone is struggling with allocations to a fixed-income market that seems exceptionally over-priced. Cash rates remain near zero, and the 10-year Treasury yield—at 1.65%—sells at a 61x P/E multiple for a coupon without any growth! Moreover, junk-yield spreads are near record lows, and investment-grade credit spreads are at their tightest levels in at least 20 years. Finally, it’s a pretty good bet that yields are headed higher in the next few years.
Do You Know Your “Labor Liability?”
After significantly decreasing in the previous decade, employee compensation of U.S. corporations, as a percent of nominal GDP, has risen slowly but steadily since 2010. That is, rising labor costs have proved to be a modest but growing challenge for labor-intensive industries.
Inflation Fears Are Surging… But So Are The Fundamentals
It’s been a tough week for investors. Although the Federal Reserve has been trying to prepare us for a “transitory” inflation spike, a single-month surge to a 26-year high in the core, annual consumer-price inflation rate has challenged the Fed’s narrative. After all, many thought it was only a matter of time before the overuse and abuse of monetary and fiscal policies would come home to roost.
It’s “REVAL” Time!
Most bull markets of the last 40 years commenced when company fundamentals and earnings were still declining from a recession. Because of that, valuations often worsen considerably during a fresh bull run as the stock market surges despite continued earnings weakness.
Gold Suggests Only “Transitory” Inflation?
Investors turn to gold when they fear inflation. Therefore, historically, the price of gold has often significantly outpaced other commodity prices “before” the rate of consumer inflation accelerates.
Will Cyclicals Keep Cruising Or Crash?
As the economy recovers from its COVID bust, cyclical stocks have enjoyed a nice run. Based on a geo-weighted index of the primary, economically sensitive sectors comprising the S&P 500 Index—Materials, Industrials, Consumer Discretionary, and Financials—cyclicals have outpaced by +4% this year and close to +10% over the last year, but it has not been uneventful.
A Self-Sustaining Bull
The current Bull Market has so far exhibited an attractive self-sustaining character. The accompanying charts highlight the relative performance of eight distinct investment attributes: Value, Growth, Cyclical, Price Momentum, High Quality, Small Cap, EM, and High Beta. Although each of these has had its day in the sun, no single investment attribute has persistently dominated since the Bull Market began after the March 23, 2020, Bear Market low.
Meet The “Inflation Slayers”
A sustained period of significant inflation is probably the biggest risk facing investors. Signs abound that inflationary pressure is building. The S&P GSCI Commodity Price Index has more than doubled from its lows last April, bond-market breakeven rates have surged this past year (i.e., illustrating bond-investors’ inflation expectations), and both manufacturing and service-sector companies report some of the strongest selling-price flexibility on record.
Sustained SURPRISES!
Last week, a unique character of the contemporary, economic recovery was highlighted. Blowout numbers were widely anticipated for the retail sales report on Thursday and expectations were huge. Nonetheless, when the early-morning report was released, the actual numbers were nearly double the elevated forecasts.
Small Caps Stagger?
After steadily rising since last fall, small-cap stocks have recently staggered. Although the Russell 2000 is off by only about 5.5% from its record high in mid-March, it has underperformed the S&P 500 by almost 10%.
Monday’s Musings?
Just a few unrelated thoughts to ponder this afternoon…
Are The Wealthy Feeling Healthy?
Not surprisingly, confidence among the highest earners is generally more positive than that of low earners. However, the extent of this “confidence-differential” will vary over an economic cycle. The confidence-differential compares the results of the highest 33% of earners to that of the lowest 33% of earners, based on the University of Michigan’s Consumer Sentiment Index.
When Leadership Fades?
The seventh-longest persistent period of leadership by a single U.S. stock-market sector since 1928 came to an end in March. What does this imply, if anything, about the future of the contemporary bull market?
The Dubious DOLLAR?
The U.S. dollar declined last year, but, so far, in 2021, the dollar has been rising. U.S. bond yields have surged far more than foreign yields lately, making dollar investments more attractive. However, U.S. inflation is definitely accelerating, which is never good for the U.S. currency.
Running It HOT!
Because of extraordinarily accommodative monetary and fiscal policies, a complete synchronization of the global-economic expansion, unprecedented savings, substantial pent-up demand, a post-pandemic reopening, and a record-low inventory/GDP ratio, the U.S. economy is poised to run HOT!
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