In the month of July 2021, the S&P 500 showed continued strength by gaining 91 points (+2.1%) from 4304.1 to 4395.26.
July 2021 was also a volatile month, which saw a temporary drawdown (peak to trough) move from 4395 to 4235 (-3.63%) (-3.63%) due to higher than expected inflation results and also the Covid delta variant spread around the world.
However, that bout of selldown was quickly reversed when the Fed Chairman Jerome Powell signalled to the market that they will remain highly accommodative and that the Fed’s opinion of the inflation situation remains transitory. Furthermore, the Fed expects the Delta variant to impact the global economy but not derail it like what happened more than a year ago.
In terms of key levels, the S&P 500 managed to achieve 7 separate all-time high instances in July.
Going forward, if there are no major catalysts that will change the ongoing market narrative, we can expect the S&P 500 to trade within the turquoise trend channel below. S&P 500 will likely be constrained at the 4480 resistance level in the short term, with 4320 acting as key support.
In terms of managing downside risks, if the critical 4236 support level fails to hold, this likely means that the stock market will be faced with unexpected market concern(s) that have the potential to trigger further downside below 4236.
TAKEAWAY
- The market posture ending July 2021 looks very constructive.
- Not only did the S&P 500 manage to make 7 all time high instances in the month of July, it was able to close +2.1% for the month.
- Market participants in the world’s largest economies have already started to think out of the reflation/reopening narrative which is in its last innings, into a post pandemic economy.
- This means that the largest Central Banks and governments are/have started to peak their monetary and fiscal policies, and we are already seeing evidence of this occurring.
- In a post pandemic economy, traders and investors will mostly be focusing on how persistent inflation will be, and whether the economic growth will start to stall.
- Transitory inflation and continued economic growth will push the US stock market higher, while persistent inflation and dampened growth will stall not only the economy but also the equities market.
- To be clear to our community readers, a slowing economy does not equate to negative returns. Historically such conditions have pointed towards a cooling off period coming right out of a recession.
- In fact the last two peaks in earnings cycles have resulted in double digit returns over 1, 3 and 5 year periods. While history may not repeat itself this time, the most important point to articulate to our community readers is that peak growth does not necessarily equate to a long term bearish outlook.
Big Picture - Global Overview
Investors and traders should start to shift their focus beyond the re-opening theme that had been ongoing for the past year, and start to think about the macro factors driving the post pandemic global economy.
Most of the world’s largest economies are well underway in their path towards re-opening, as vaccination campaigns have accelerated in the United States, China, and Europe. Especially in the United States, which has more than 50% of the population fully vaccinated, there is evidence suggesting Covid-19 might evolve into an endemic. Even though the Covid Delta variant spread is creating yet another wave in the US, hospitalisation and death rates are on the decline.
The path to re-opening is proven, appears realistic and achievable. Uncertainties on future covid variants and how they may impact economies have reduced significantly. The common consensus is that the world’s largest macro economies are probably in the last innings of the reflation/reopening theme. The most important question going forward is – what’s going to happen next?
There is no doubt that most global macro factors remain supportive and market friendly towards risk assets like equities. US Growth rates globally will likely continue to increase for the remainder of 2021 and perhaps even into 2022 based on the Fed’s current assessment, which implies that monetary and fiscal policies will remain accommodative.
However, it must be highlighted that the equities market is a forward looking discounting machinery. It prices what is expected of the future based upon current expectations. So while global macro factors appear very supportive in absolute terms, there is a growing sense that they are showing diminishing effects. Thus, a forward looking equities market may start to price in ‘Peak Macro’, which suggests a bumpy road ahead.
Evidence of Peak Macro Factors
Global Monetary Policies
There is increasing evidence that central banks globally have signalled or directly announced they will be easing off on the acceleration pedal.
| Country | Details |
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USA - The central bank of the world’s largest economy has signalled that several Fed members will like to start ‘thinking about thinking about’ tapering1. This is a slight shift from the previous stance of ‘not thinking about tapering’ at all. The Fed knows that financial markets have grown very used to a communicative Fed which is why this ‘Heads up’ approach should not be taken lightly. Furthermore, before the Fed starts raising interest rates it will already have begun to shrink the Central Bank’s asset purchasing program. |
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China - Since early 2021, the People’s Bank of China (PBOC) has already started to decrease its injection of short-term cash into the economy. Furthermore, the PBOC has expressed concerns of rising debt, credit risks and asset bubbles, and have already started curbing credit growth to stabilise debt ratios without causing any knee jerk reactions to markets.2 |
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Europe - the European Central Bank (ECB) recently announced3 that they will start tapering its Covid-related asset purchases after its September meeting and will cease buying them completely by the end of March 2022. |
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UK - The Bank of England (BOE)4 has decided on its rate forecast as of May 6 2021, and its Quantitative Easing (QE) schedule is expected to be completed by the end of 2021. |
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Japan - The Bank of Japan (BOJ) announced5 in March 2021 that it will widen the band of the 10 year bond yields to rise and fall between 0.25% and 0%, as opposed to 0.2% and 0% previously. This is sending a signal to financial markets that the BOJ is building in flexibility to allow rates to increase. Furthermore, the BOJ is also seen to be removing a pledge to buy exchange traded funds (ETFs) at an annual pace of 6 trillion yen. |
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Canada - The Bank of Canada (BOC) was the first central bank in the world that signaled it would exit its stimulus program in April 2021. Expectations are also for the BOC to raise its key interest rate by 25 basis points to 0.5% in the final quarter of 2022. |
Fiscal Policies
| Country | Details |
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USA - In terms of the fiscal policy outlook for the USA, it looks like a mixed bag which can imply US fiscal policy may have started to peak, with little to no more surprises to the upside going forward. A Covid Federal unemployment program6 that has been paying jobless benefits since March 2020 is scheduled to end on 6th September 2021, with no indication from Congress it will be extended. The Federal government issued a housing eviction ban7 to protect American renters in September last year due to the pandemic. That federal protection is due to expire in August 2021. On the other hand, the $1 trillion bipartisan infrastructure bill8 is looking likely to be passed by the Senate, which will be bullish for construction, electric vehicle and water piping stocks. The additional $3.5 trillion Budget Reconciliation Bill9 (includes the $1 trillion infrastructure bill) is thus far looking less likely to gain bipartisan support with several Democrats raising concerns over the bill and almost all Republicans likely to cast a ‘No’ vote. |
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China - Since June 2021, the China government embarked on a series of regulatory restrictions aimed at curbing speculations, asset bubbles and restoring balance to an overheating chinese economy. The Chinese government first started to crackdown hard on cryptocurrency mining10, which sent Bitcoin tumbling below $30,000. China also restructured its 1 child policy to increase it to 2 children, and to support this policy it issued new rules11 to ease pressure on children and family living costs. China also tightened regulations12 for loans to the property and mortgage loan sectors. Very recently, Beijing also sought to rein in Chinese Big Tech companies13 after the likes of Alibaba and Didi ruffled the feathers of the Chinese government. Beijing’s view is that these Big Tech companies have contributed to an irrational expansion of capital plus their use of artificial monopolistic practices have threatened competition and social stability. |
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US Anti-Trust - Similarly, the US Biden Administration is also not resting on their laurels by assembling a star studded Antitrust team14 who have spent their careers opposing corporate consolidation to the likes of Facebook, Amazon and Google. |
Wall Street is circulating around a narrative around diminishing economic returns as the US economy transits away from the re-opening narrative to a post pandemic economy.
This is despite the US Fed and Federal government flooding the economy with trillions of funding and liquidity measures. This unprecedented level of liquidity has fuelled an unprecedented level of inflation not seen in the past 40 years, yet there are early indicators that growth is starting to wane. For example, GDP, the total of all goods and services produced in the economy, jumped 6.5% for the 2nd quarter of the year and failed to beat the 8.5% estimate. Correspondingly, Inflation climbs higher than expected in June as the price index rises 5.4%, above the expected forecast of 4.9%, and also above the previous month’s 5% increase.
In summary, we have seen inflation coming in higher than expected, and GDP growth coming in lower than expected in the month of July.
If this trend were to persist, most economists term such a scenario ‘Stagflation’. Stagflation is an environment whereby inflation becomes higher as growth moves lower.
Coincidentally, this was something the US had to deal with 4 decades ago from the mid-1970s to early 1980s.
US Earnings
As of end July 2021, US companies are already halfway through their second quarter earnings. So far, the results have been stellar, with US companies managing to beat forecasts expectations and more importantly provide higher forward guidance on revenue growth in subsequent quarters and 2022.
S&P 500 Companies Revenue and Earnings (YoY)15
On average S&P 500 companies that have reported earnings had revenues up 21% (YoY) and earnings up 86% (YoY). The earnings beat is the highest since Q4 2009. Earnings are coming in 18% above expectations, well above the historic norms of 3-5%.
S&P 500 Companies Q3 and Q4 earnings estimates16
As of end July 2021, S&P 500 companies have forward guided Q3 estimates upwards to 28.3% compared to 24.7% as of 1st July 2021.
Similarly, forward guided Q4 estimates have increased to 20.3% compared to 17.3% as of 1st July 2021.
US Earnings climb a wall of worry
Despite the earnings beat this quarter, and better than expected future estimates, many traders are concerned over the high valuations. For example, the average S&P 500 company is currently trading at 20 times 2022 earnings estimates which is a historical high. We have also seen some ‘Sell the news’ type price action to the likes of Apple17, who have reported earnings that beat at every metric yet experienced a -1.7% sell down on heavy volume.
High valuations and seasonal weakness as typically seen between August and October, present the most realistic near term market risk. The Covid delta variant that is lurking at the sidelines is ever ready to take centre stage in an environment ready to jump on any negative news.
Market Outlook
The key to navigating the equities market in the coming month and beyond is to focus on economic growth and inflation expectations.
Bearing in mind GDP data is usually released only on a quarter basis, and the latest GDP results were issued on 29th July 2021, means market participants will be looking for clues within GDP proxies that are reported more frequently.
AlgoMerchant community readers can refer to the summary table with details on GDP and inflation proxies and their reporting dates to make informed trading decisions based on these economically sensitive data.
Conclusion
The tone of this month’s article may appear to be highly cautionary, and may be construed that markets have peaked and a big correction is imminent.
However, that is not the case. To be certain, a slowing economy does not equate to negative returns. Historically such conditions have pointed towards a cooling off period coming right out of a recession.
In fact the last two peaks in earnings cycles have resulted in double digit returns over 1, 3 and 5 year periods. While history may not repeat itself this time, the most important point to articulate to our community readers is that peak growth does not necessarily equate to a long term bearish outlook.
The US equities market can and may continue to provide positive returns looking out 1 to 5 years from now.
Please note that all the information contained in this newsletter is intended for illustration and educational purposes only. It does not constitute any financial advice/recommendation to buy/sell any investment products or services.
Disclaimer: Please note that all the information contained in this newsletter is intended for illustration and educational purposes only. It does not constitute any financial advice/recommendation to buy/sell any investment products or services.
2https://www.businesstimes.com.sg/banking-finance/bubble-risks-test-chinas-commitment-to-no-sharp-turn-in-policy
3https://www.reuters.com/world/europe/ecb-taper-pandemic-buys-after-sept-covid-19-variants-top-risk-2021-07-13/
4https://www.reuters.com/world/uk/bank-england-keeps-rates-size-bond-buying-plan-hold-2021-05-06/
5https://www.reuters.com/world/asia-pacific/boj-widen-band-around-long-term-rate-target-friday-nikkei-2021-03-18/
6https://www.cnbc.com/2021/08/01/an-unemployment-cliff-is-coming-more-than-7point5-million-may-fall-off.html
7https://www.cnbc.com/2021/07/28/a-historic-eviction-crisis-could-be-coming-to-the-us-in-just-days.html?recirc=taboolainternal
8https://www.cnbc.com/2021/08/02/senate-finishes-text-of-bipartisan-infrastructure-bill-after-rare-weekend-session-.html
9https://www.newsweek.com/joe-manchin-questions-35tn-price-tag-dem-budget-reconciliation-bill-1615051
10https://www.theverge.com/2021/6/23/22544367/china-crypto-crackdown-bitcoin-mining-sichuan-ban-hydro-cryptocurrency-trading
11https://www.channelnewsasia.com/news/asia/china-to-unveil-tough-new-rules-for-private-tutoring-sector-15031240
12https://news.cgtn.com/news/2021-01-01/China-tightens-regulation-for-loans-to-real-estate-sector-WGFMZi7Tri/index.html
13https://www.scmp.com/tech/big-tech/article/3143241/chinas-big-tech-crackdown-will-beijings-efforts-kill-countrys-most
14https://www.nytimes.com/2021/07/24/business/biden-antitrust-amazon-google.html
15https://lipperalpha.refinitiv.com/2021/07/this-week-in-earnings-9/
16https://lipperalpha.refinitiv.com/2021/07/this-week-in-earnings-9/
17https://www.cnbc.com/2021/07/27/apple-aapl-earnings-q3-2021.html
