For now, the US Treasury market seems to share the Federal Reserve’s view that inflation will remain largely under control even after a few months of impressive levels. Underneath the relatively sanguine surface, however, there is an undercurrent of concern.
The concern is that 10-year government bonds TMUBMUSD10Y, 1.293%,
which currently fluctuate around 1.30% – together with break-even rates, which lead to annual price gains of around 2.3% over the next ten years – underestimate the risks of a longer period of higher US inflation.
And when these risks come into play, long-term yields rise and the yield curve steepen, as in the first quarter, “this can lead to a great deal of volatility in all asset classes,” as bonds sell out, credit spreads widen and stocks fall, said portfolio manager Scott Rüsterholz from Insight Investment, which manages more than $ 1 trillion.
Recent comments from prominent investors like Larry Fink of BlackRock Inc. and Jeffrey Gundlach of DoubleLine Capital only underscore concerns that the market is too complacent.
Two consecutive months in which the US consumer price index rose to or above 5% unsettled parts of the financial markets. And targeted questions from lawmakers during Fed Chairman Jerome Powell’s semi-annual testimony to Congress last week may have heightened fears that the central bank is misjudging the ongoing price pressures caused by the pandemic, even if the chairman ” a shock “admitted going through the system associated with the reopening of the economy.”
A painful ride
“There is definitely a risk the market is wrong here,” said Mark Heppenstall, chief investment officer of Penn Mutual Asset Management, which operates $ 33 billion out of Horsham, Pennsylvania. The CIO sees the possibility that consumer price headlines will hit between 3% and 4% in the next six months, as the gross domestic product, or GDP, hits 7% to 8% for the year, pushing the 10-year treasury back towards 2% presses. On the other hand, should higher inflation and slower economic growth come into play, this could “create a push-pull dynamic in interest rates that will make the bond market more manageable”.
The outlook for bond investors for the remainder of 2021 depends heavily on the outlook. Bonds are hit hardest of all asset classes by higher inflation, undermining the fixed value of bonds, and some investors cannot take long to offset losses. “There will be stress in other investment markets,” said Heppenstall in a telephone interview. “But it could be a painful ride for long-bond investors.”
Another Fed Confab is emerging
Investors are largely looking beyond the US economic reports due next week – which include real estate-related data on Monday and Tuesday; weekly unemployment claims on Thursday; and monthly purchasing manager indices for production and services on Friday. They are instead focusing on the July 27-28 Fed meeting in Washington, where policymakers are likely to continue their discussions on reducing bond purchases while taking what Powell calls what Powell calls “more humble” thinking about it assume on inflation.
Fed officials will be in a traditional blackout on speech leading up to this gathering for the coming week.
Meanwhile, several forecasters are already anticipating months of increased exchange rates that are well above the Fed’s 2% target. Fannie Mae economists predict that consumer prices will stay around 5% year-over-year through the end of 2021. Barclays Plc employees expect a 6% year-over-year CPI for December, while Wells Fargo & Co. is forecasting a 4% full-year CPI – which should stay around 5% through December.
Insight Investment’s Rüsterholz sees the likelihood that inflation will remain above 3% through the second quarter of next year, given the strong US economic growth, before falling back to 2.25% to 2.5% by the end of 2022, which opens again hotels, increased consumer travel and used car sales should eventually dissolve, while disrupted supply chains are likely to “fix themselves”, says the New York-based portfolio manager.
Rüsterholz says that Insight invests in “high-yield, growth-sensitive assets” with lower credit quality and in collateralized loan obligations (CLOs), and that he sees Treasury Inflation-Protected Securities (TIPS) as “interesting” to play a higher inflation scenario.
Check out: With inflation rising, the expert on BlackRock’s iShares investment strategy says clients are “confused by interest rate movements”.
“We need to be aware that the forces that keep inflation high have been much stronger than expected, and we run the risk that the longer it happens, the more likely that inflation will move into other categories, investor psychology and expectations,” he says .
The stock outlook
Last week, the Nasdaq Composite Index COMP finished the week lower for the first time in about a month, -0.80%, and the Russell 2000 Small Cap RUT Index fell more than 4.5% and -1.24% marked its worst week since October 30th and the third consecutive weekly decline.
In other words, in absolute terms, neither growth stocks, such as the tech-heavy Nasdaq, nor the value sector, which is reflected in Russell, did well in July.
What works? The biggest of the big ones outperformed so far with the Nasdaq Composite Index COMP, -0.80% more than 1.2% compared to the month. That momentum is also helping the S&P 500 SPX, -0.75% and the Dow Jones Industrial Average DJIA, -0.86%, make gains so far this month.
“The S&P 500 is up 4% since June 3rd, but ~ 80% of that move can be attributed to the top 5 stocks,” wrote Larry Adam, CIO of Raymond James’ wealth management unit, in a weekly research report.
However, Adam said he wasn’t too concerned about the narrow range of earnings stocks.
“A narrowing width is a sign of internal weakness and can sometimes precede phases of withdrawal. We are aware of this, but not overly concerned given the strong medium-term tech backdrop and market bias
for the sector rotation later, ”he wrote.
FactSet Research’s John Butters says 85% of S&P 500 companies have reported positive earnings per share surprises so far for the second quarter.
“If 85% is the last percentage, it is the second highest percentage of the S&P 500 companies reporting positive EPS surprises since FactSet started tracking that metric in 2008,” he wrote on Friday.
He said the mixed earnings growth rate, including actual results and estimates, for the second quarter of 2021 for the S&P 500 is 69.3%, which would represent the index’s highest annual earnings growth since the fourth quarter of 2009 (109.1%) when figures stop.
Adams says that better-than-expected quarterly results for American companies “are due to the surprising resilience of the US economy; When the reopening is fully realized, however, many of the analysts’ estimates that cloud the uncertainty will wane, and so will the size of the blows. ”
Raymond James will seek guidance from CEOs and CFOs on how things are going for the next three months and the full year.
RESULTS REPORTS BY 19.-23. JULY
MONDAY: IBM, Tractor Supply, JB Hunt
TUESDAY: Netflix, Chipotle
WEDNESDAY: Coca Cola, United Airlines, Johnson & Johnson, Verizon, Texas Instruments, eBay, Anthem, Baker Hughes
THURSDAY: Intel, Snap, Twitter, American Air, AT&T, Domino’s, Biogen, Abbot, Equifax
FRIDAY: American Express, Schlumberger