Volatility Settles, Asset Markets Steady but Better: Week Ended May 28th
After a couple of weeks characterised by high volatility and slow starts / strong finishes, this past week was void of nearly as much drama. Volatility settled and most asset categories moved in narrow ranges throughout the week, albeit generally better bid reflecting the more constructive tone. Equities marched steadily upwards and were green across the board in the international and US indices I track, with only Tuesday proving to be slightly problematic for US markets. Internationally, Asia had the best performing markets (Japan and China) this week, and emerging markets overall did well because of its heavy Asian weighting. The FTSE 100 was the laggard although just in the green for the week, whilst the broader European market (via STOXX 600) was better every single day albeit modestly.
In the US, the positive performance was broad with the indices green across the board. There was perhaps a slight tilt back in favour of value (Russell 2000), although the tech-heavy NASDAQ Composite – which has been under pressure since mid-February – turned in the second best performance of the week amongst the US indices.
As mentioned already, volatility was much less on the week, perhaps correlated with lessening concerns (again) about inflation and simply the lack of surprising news. The VIX trended down most of the week, closing Friday at 16.76, having hit an intraday high on May 12th of 28.38. There were also more S&P 500 companies that reported earnings this week, which – similar to most companies that have reported 1Q21 results – came in better than analysts’ consensus expectations. Companies reporting that best expectations included Urban Outfitters, Zscaler, Toll Bros, Cracker Barrell, Nvidia, Dicks Sporting Goods, SalesForce, Costco, Best Buy and Dollar Tree. 489 of the S&P 500 companies have now reported earnings for the quarter, with 87.3% beating analysts’ consensus expectations (long term average around 65%), and 78.1% beating top-line consensus expectations. Still, better-than-consensus earnings has not necessarily been a benefit to many companies as far as stock price increases, serving more perhaps to justify valuations which remain inflated in many cases. This will take more time to work through the system. The weekly report from Refinitiv is the best source for reviewing prior week’s earnings, and I highly recommend you give it a quick read. The May 28th report can be found here.
US Treasury yields drifted slightly lower during the week as inflation concerns once again faded into the background, providing more stability to other markets. Government bonds in the UK, the Eurozone and Japan were also stable. The Biden Administration released its much-anticipated but well-telegraphed 2021-2031 budget at the end of the week, outlining the Administration’s $6 trillion spending bonanza. The budget, which you can find here, projects that the US debt-to-GDP will increase to 117% by 2031 (see last page of budget in tables), certainly to continue to put pressure on government bond yields and the US Dollar.
I wrote about my views on inflation (transitory or persistent?) in an article this week that you can find here. In this article, I compared the post-pandemic economy in the US to the high inflation economy that existed in the 1970s/early 1980s. My view is that inflation will be transitory, with the larger risk being the effect on economic growth when the Federal Reserve begins to take steps to temper inflation. Having written this, I do believe that we can’t carry on with negative real interest rates and that government yields will eventually increase once the artificial support from the Fed is withdrawn. Longer-term, I also am concerned with deficits, in fact increasingly so. President Biden and his party seem to have limited discipline as far as expenditures, as the Administration is proposing an increase in spending that is unprecedented since just after WWII. Higher interest costs caused by larger debt amounts and eventually increasing interest rates will be a drag on future economic growth, a problem left for future generations to sort out. Personally, I don’t feel right about this, although to be fair it has been a recurring problem since the late-1990s, with the Clinton Administration in the 1990s the last one to run a federal budget surplus.
The tone of the corporate credit markets largely matched that of the equity markets, as spreads somehow continue to grind tighter and tighter. It is hard to believe that the BBB-corporate credit (BofA index) is yielding 2.36% (+1.13% over USTs) and US high yield is yielding a mere 4.24% (+3.30% over USTs). However, there are few relative value alternatives that can offer these types of current returns. Clearly, near-zero underlying rates and the Fed hoovering up corporate bonds across the credit spectrum has wrecked the market from an investor’s perspective, but rest assured this will be reversed in due course. If you are lamenting these returns in USD, let me make you feel a bit better. The EUR high yield market is yielding only 2.46%, a spread of 2.99% over Bunds (which have a negative yield). Here’s a summary of how corporate credit spreads in USD and EUR (HY) have migrated by rating bucket YtD.
As far as other assets, the performance was similar to that of equities for much of the week – steady but generally better.
Gold continued its steady increase albeit more measured this past week even as volatility in the markets more broadly waned, closing at $1,909.48/ounce (+1.6% W-o-W). This was the fourth consecutive week that gold prices have increased, capping off a gain of 11.8% in the 2Q21 to date. The US Dollar was more or less flat, although most economists and investors seem convinced that the world’s reserve currency will continue to weaken as the recovery shifts to other more attractive markets and the US racks up deficits. The Yen weakened again, down 0.8% W-o-W, perhaps reflecting concerns in Japan over growing cases of CV19 and questions around the upcoming 2021 summer Olympics. Oil prices increased, bringing oil’s gain to 37.3% YtD. Cryptocurrencies remain under pressure and are subject to wild price swings, although Bitcoin managed to flatline on the week.
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