Most of this past week was lousy for global equities, that is until investors rode to the rescue on Friday and pulled the US stock market out of its funk. Friday’s gains managed to steady global equity markets and salvage a sleepy August week in the US and Europe that could have been much worse. Volumes in equity markets have been relatively subdued recently, not uncommon in August, which has undoubtedly excaserbated price volatility.
The most commonly-used measure of risk in the market – the VIX, or “fear index” – steadily widened throughout the week until Thursday’s close, going from around 16 at the open on Monday to nearly 25 at the intraday high on Thursday. With some sense of stability returning to the US equity markets early in Friday’s session, equities found their
footing and risk took an about face as the VIX plummeted, in the process clawing back most of the week’s significant increase.
Even though US and European equities ended up much better than they looked like they might before Friday, there remains a confluence of on-going concerns weighing heavily on markets, all well covered by the mainstream financial media. In a nutshell, these are:
Timing and methodology for tapering, a topic that is increasingly an area of focus by investors. The FOMC minutes for the meeting held July 27-28 were released on Wednesday, leading to much speculation as to when tapering would begin. Economists seem to have settled on a bid-ask of December 2021 to end of 1Q22. You can find the FOMC minutes here.
China continues to tighten the screws on many of its technology-related companies through its focus on data privacy regulation and more robust efforts to increase competition particularly for companies relying on the internet. There are also growing concerns about the growth of the Chinese economy, the world’s second largest, due to the Delta variant.
Mixed economic data in the US, the world’s largest economy. Retail sales released on Tuesday were weaker-than-expected for July (see Census Bureau report for July here), falling 1.1%. Countering this,
Earnings of US companies generally continue to surprise on the upside, although guidance is becoming more cautious because of cost-side pressures and the direction of the pandemic.
Concerns about the Delta variant of COVID-19, which are causing cases to surge again in several countries around the world. In the US, it is the states with some of the lowest vaccination rates that are most at risk of running out of ICU beds in hospitals, including Florida, Louisiana, Mississippi and Arkansas. The graphic below shows the percentage of ICU beds taken in the US (source: New York Times, article here).
Valuations remain elevated in US equity markets. The S&P 500 has a valuation around 21x forward earnings, the same level as just before the tech-bubble burst in 2001. The Schiller P/E ratio is 38.3x. The Schiller P/E ratio ranged in the high 20s/low 30s since the beginning of 2017 (aside from March 2020) but began to move out of this range early in 2021, steadily climbing to its current level in the high 30s. The graphic below depicts the Schiller P/E ratio for the S&P 500 since 1880, so you can get a sense of where we are as far as valuations vis-à-vis historic levels.
For these reasons, investor sentiment seems to be souring somewhat as it feels like – Friday’s rally aside – there is a clear bias towards risk-off. Within equities, this means that there could be a tilt towards less volatile and less cyclical sectors, since companies in these industries are less correlated with economic growth and are cheaper from a valuation perspective. Such sectors might include utilities and consumer staples for example, both considered “boring sectors” and clear laggards during the pandemic-recovery. You can read more about sector performance over time in my last article in E-EmorningCoffee here: “A look back during the pandemic: sector ETFs”.
Going forward, I expect volumes to remain subdued as we move into the latter third of August, with perhaps the most important calendar event this coming week being the Central Bank Economic Symposium which is in Jackson Hole on Friday (Aug 27th). The symposium – “Macroeconomic Policy in an Uneven Economy” – has taken on a less international flavour that usual and is expected to focus mostly on the US economy. You can find out more about the symposium including the agenda, speech transcripts, etc at the sponsor of the event, The Kansas City Federal Reserve Bank, here.
Below is the table showing returns for the global equity indices I track.
The S&P 500’s solid performance on Friday, racking up a gain of 35.87 points (+0.8%), salvaged the week for the US index, although it is was “too little, too late” to do anything other than stabilise things in Europe on the day. The Japanese stock market remains under severe pressure, down nearly 10% in six months. As badly as some well-known Chinese tech names like Alibaba, Didi and Tencent have done over the last several weeks, the broader Chinese equity market has managed not to do as badly. Still, plenty of investors have decided to exit China completely until there is more clarity on the government’s crackdown on its technology companies, and the rules-of-play become better defined.
Stateside, it didn’t really feel like the tech-heavy NASDAQ Composite was the best performer of the week but in fact it was. The narrower and more cyclically-sensitive DJIA was down a bit more, but the pain was again more severe in the Russell 2000. After outperforming the other US indices in January and February as value took centre stage, the Russell 2000 largely has fallen out of favour since and now has the worst return of the four indices I track YtD.
Yields on USTs in the belly and longer end of the yield curve declined last week. USTs continue to exhibit rather remarkable resiliency, having for now largely seen off concerns about persistent long-term inflation. The yield curve is continuing to flatten ever so slightly, suggesting an ongoing bias towards concerns over future US economic growth.
Similar to USTs, the price direction of WTI crude is also suggesting growing concerns about future global economic growth. The price of WTI crude fell 9.1% last week, and is now down 15.8% since the beginning of July as investors increasingly worry about many of the factors I mentioned at the beginning of the weekly, with pandemic variants undoubtedly being at the top of the list.
As risk became more visible in the markets last week, the USD strengthened, causing cross-currency exchange rates for, amongst others, the EUR and GBP, to decline against the USD. Gold did marginally better W-o-W, but is not behaving like there is undue financial markets risk ahead. The star though as far as asset performance over the last several weeks has been Bitcoin. Don’t ask me why, but the cryptocurrency has come well off its July lows and is up nearly 66% in the last month alone.
We are coming on the last full week in August, with holiday-shortened weeks in the UK (week of Aug 30th) and the US (week of Sept 6th) ahead. I would expect volumes to remain light and volatility heightened, with directional moves hard to call aside from continuing with a negative bias in equities for the moment.
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