Weekly Market Recap

Last week was a challenging one for most risk assets, as investors recalibrated their global growth expectations in the face of the rapidly spreading delta variant of SARS-CoV-2. In the US, large cap stocks were mostly lower, with only traditional defensives like utilities (+2.6%) , staples (+1.3%), and real estate (+0.7%) registering small gains. Cyclicals (particularly energy) came under selling pressure, as did small and midcap companies. International stocks were mixed, with developed markets lower on the week while E/M finished higher.

US Treasuries were treated as a safe haven, sending yields lower and bond prices higher. 10y and 30y Treasury yields both fell 7 basis points on the week, pushing the 2s10s curve to 107 basis points, the lowest since mid-February.

After touching a new pandemic-era high on Tuesday, oil prices fell on Wednesday and Thursday, finishing the week at 1-month lows.

Economic data was mixed. In encouraging news, Empire Manufacturing was very strong, retail sales were up sequentially, and weekly jobless claims continue to trend lower. Conversely, the Philly Fed’s monthly business outlook declined, the University of Michigan’s Consumer Comfort gauge was down, and inflation data (CPI and PPI) for June came in higher than expected, with headline CPI reaching +5.4% y/y while core CPI was +4.5%. As was the case in the previous two months, most of the drivers of above-trend inflation appear to be transitory factors related to the reopening of the economy.

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Weekly Market Recap

Weekly Recap: Equity markets rode a roller coaster fueled by inflation fears last week, with most stocks finishing lower. Headline inflation (as measured by CPI) rose above 4% for the first time since 2008, causing a short-lived spike in interest rates as well as widespread selling in equities as discount rates were
recalibrated. The fear of persistently higher inflation began to subside a bit
on Friday, allowing rates to fall and equities to recoup some of their losses.

Large cap tech stocks were hit the hardest, dragging down sector
performance for communications (-2.0%), information technology (-2.2%), and consumer discretionary (-3.7%). Meanwhile, cyclicals as well as traditional defensive sectors were mixed, with only consumer staples
(+0.4%), financials (+0.3%), and basic materials (+0.1%) finishing higher on the week.

Interest rates finished the week modestly higher, with benchmark 10y
Treasury yields rising 5bp while 30y yields were up 6bp. Credit spreads were mostly stable, resulting in small price declines across all sectors of the bond market on the back of the rise in Treasury yields.

Oil prices rose, with WTI closing back above the $65/barrel threshold.
Meanwhile, the national average price of gasoline rose above $3 per gallon
for the first time since late 2014. See the Chart of the Week for a time series.

Albion’s “Four Pillars”: Economy & Earnings – GDP growth was +6.4% annualized in Q1 2021, and is forecast to accelerate to +8.1% in Q2. Meanwhile, EPS for the S&P 500 turned positive y/y in Q4 2020 and will rise significantly y/y in Q1 2021 as the economy laps the onset of the pandemic.

Equity Valuation – the S&P 500’s forward P/E of 22x is above the historical average, and long-term valuation metrics like CAPE (cyclically adjusted P/E ratio) suggest that compound annual returns over the coming decade are likely to be in the single digits. That said, lower equity returns may be justified in the context of ultra-low yields on alternatives like bonds and cash.

Interest Rates – Rates remain low by historical standards despite recent
volatility, supporting equity valuations and lowering borrowing costs.

Inflation – After staving off deflation early in the pandemic, the Fed has
communicated tolerance for short periods of above-target inflation. A
cyclical bump in inflation may occur in 2021 as pent-up demand is released, testing the Fed’s resolve, but we do not expect higher inflation to persist.