Week Ended Aug 13th 2021: Inflation runs hot, markets don't care
This past week started with earnings last Saturday from Berkshire Hathaway (BRK), always closely watched, then was followed Monday with a “flash crash” in gold and silver. BRK delivered solid if unspectacular results (stock +0.8% W-o-W), generally the norm for the team of Buffet and Munger. As far as the “flash crash”, I still don’t understand the catalyst(s) that caused this. However, gold clawed back its sharp losses after falling briefly below $1,700/ounce on Monday, actually closing up 1.2% W-o-W. Both CPI (Weds release, 5.4%, BLS release here) and PPI (Thurs release, 7.8%, BLS release here) were very high compared to recent levels but in line with expectations, so neither really caused too much movement in the US Treasury bond market. After the 10-year yield peaked on Wednesday, it fell back and actually ended up down 2bps W-o-W (at 1.29%). US equities barely moved most of the week although there was a tilt towards reflation stocks at the expense of value and momentum, but it was modest tilt at best.
Globally, developed market strength was mainly in Europe, with the FTSE 100 and the STOXX 600 returning solid weekly returns of 1.3% and 1.2%, respectively, both outperforming the S&P 500 (+0.7%) and the Nikkei 225 (+0.6%).
It is (low volume) August, which needs to be kept in mind, but concurrently there is clearly a “tug-of-war” going on between inflation and economic growth. Given what is going on in the UST bond market (as far as yields) and the US equity markets (as far as tilt), I think that the outlook remains fairly well balanced. Inflationary concerns are not necessarily fading, as July data indicates, but both bond and equity investors seem to increasingly be buying into the Fed’s argument that the current high inflation is transitory. Meanwhile, the constant discussion around the pandemic – and specifically the Delta variant – is not rattling global investors, who seem increasingly able to accept that COVID-19 and its variants will be with us for some time but that the world will learn to live with it. Both the bond and equity markets feel like they are going nowhere fast in either direction at the moment.
There were a few S&P 500 companies that reported earnings this past week as the end of the earnings season draws nearer. Besides Berkshire (BRK), both DIS and ABNB were closely watched. Both provided stronger-than-expected top- and bottom-line results, although ABNB was cautious in their outlook because of the Delta variant. DIS had strong streaming results and its theme parks returned to profitability. DIS and ABNB ended the week up 2.2% and 1.8%, respectively. Earnings for the 2Q21 are nearly complete, so it is a good time to check the update from #Refinitiv (#LipperAlphaInsight) that you can find here. The most interesting things to note are that around 87% of companies have beat analysts’ consensus expectations for 2Q21 and the forward P/E ratio (3Q21–2Q22) is 21.7. From an indices perspective as I mentioned earlier, there was a tilt towards reflation / cyclical names away from value and – to a lesser extent – momentum names. The DJIA was the best performing index of the week, whilst the value-focused Russell 2000 was the worst.
Government bond yields moved up and down during the course of the week, driven mostly by the CPI and PPI releases. However, yields ended the week little changed. The 2-10 year yield curve flattened slightly, as you can see in the table below.
The fact that US government bond yields ended the week not far from where they were at the beginning of the week supports my view that the economy is navigating the knife’s edge of questions about inflation and concerns about growth (due mainly to the variants of COVID-19). Even progress on the infrastructure bill (bipartisan support, but contingent on larger social spending bill) and the follow-on, significantly larger social spending bill (Dem supported and a long way from done because will rely on reconciliation) didn’t rattle markets. Investors are expecting something at some point, and no matter what the configuration or amount, it will be another dose of fiscal stimulus to some degree. However, for now this is on the backburner of investors’ minds.
In the corporate bond market (credit markets), we also remain in the benign territory of stable spreads and only modestly volatile yields, with the latter driven mainly by level of underlying UST yields. #Moody’s is projecting that the default rate for high yield bonds will fall and remain below 2% for at least 12 months. As far as the primary market, global bond issuance was lower in 2Q21 vs 2Q20, but still remains robust. (Moody’s weekly outlook for Aug 12th is here.) As with equities and US Treasuries, for now we remain in an environment that is perfectly balanced with little pressure on credit spreads. Of course, it’s never wise to get too comfortable. The tables below illustrate corporate credit yields and spreads for BBB (investment grade) and high yield bonds (BB, B and CCC & below), and also included indices for USD-denominated and EUR-denominated corporate high yield bonds.
As far as safe havens and other assets – and aside from the “flash crash” in gold that I already mentioned – most of the week’s focus was on oil.
I sense a slight bias on the downside for oil because – unlike in the US financial markets – fears over waning demand due to the continuation of the pandemic and new variants is weighing heavy on prices. Interestingly, the #IEA reversed course and cut its demand targets for oil for the remainder of 2021 and said that it is expecting a surplus for 2022. (You can find a summary of the IEA report here.) Concurrently, the Biden Administration is taking a view the other way, asking OPEC+ to raise production targets so as to keep gasoline prices low at the pump. The oil market seems to be siding more with the outlook of the IEA. Even though WTI crude managed to eke out a small gain this week, the price is still down nearly 10% over the last month.
The best performing asset that I track of the week was #Bitcoin (#BTC). Having struggled for several months since early April, the benchmark cryptocurrency has most certainly rediscovered its mojo, up nearly 12% W-o-W and +46% in the last month. This has been the go-to asset as most other financial assets have drifted sideways. However, as I admit, what drives the movement in cryptocurrencies is well beyond my understanding. Having said this, it is getting increasingly hard not to have some modest allocation to cryptocurrencies.
This coming week brings a slew more economic data releases for July. I see little though in the next couple of weeks that inspires to me say we’re going to move higher or lower, one reason being that it is August. I welcome your views on markets in the “comments” section of this weekly update. Don’t be shy!