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Our Top Market Takeaways for October 22, 2021.

Markets in a minute: 5 observations on the market rally

Nothing changes sentiment like price. Just a few weeks ago we outlined the bear case that investors were flirting with. How times have changed. Heading into the weekend, the S&P 500 is back to all-time highs, and risk markets everywhere are climbing. U.S. banks, home improvement warehouses, next-generation automakers, and digital entertainment companies are making all-time highs. So is Bitcoin. Even Chinese tech stocks, perhaps the worst assets in the world to own this year, are up 20% from their lows earlier this month. Sovereign bonds are selling off, and implied volatility is at pandemic-era lows.   

So what is going on? Let’s try to piece it together with some observations from the past week.

1. Earnings season is off to a strong start.

Heading into Friday, 109 S&P 500 companies had reported earnings for the third quarter. 75 have surprised to the upside on sales and 89 have surprised on earnings. Coming into the season, analysts expected earnings for the third quarter to be lower than last quarter…but at the current rate, earnings will actually be 4% higher. Wondering about all those supply chain issues and labor shortages? They exist, but haven’t hindered business. Banks, for example, don’t have the same physical constraints as the goods industry and almost all of them exceeded expectations. Some companies like Nike and FedEx were punished for supply chain issues and labor shortages, but others like J.B. Hunt, Union Pacific, and Tesla showed that pricing power and flexibility help manage through disruptions. Overall, the early trends have been encouraging. Earnings growth has powered the entirety of the 20% gain in the S&P 500 this year, and we expect that to continue into 2022.

This chart shows the S&P 500 Price-to-Earnings (valuation) and Earnings-Per-Share expectations (earnings) on a rolling next twelve month basis, from January 3, 2020 to October 14, 2021. The first data point comes in at 18.2x for valuation and $178 for earnings. From here, valuation rises to 18.9x by late-February 2020, before it drops to a trough of 13x by late-March 2020. Earnings stayed steady around $178 before also rapidly declining to $142.1 by mid-May 2020. Then, valuation rapidly increases to 22.5x by early-June 2020, while earnings gradually incline to $169 by mid-December 2020. Here, valuation declines to 20.8x before bouncing to a peak of 23.1x by early-September 2020. Earnings decline a bit to $166.6, before slowly surging once more to $194.6 by early-May 2021. Here, valuation declines to 20.6x, before quickly rising to 22.2x and then declining again to 20.1x by late-October 2020. Then, valuation inclines to 22.7x before dipping to 21.3x, then quickly rising to 22.2x, and then it declines once more to 21x by early-March 2021. Here, valuation increases to 22.4x and then declines to 21.5x by mid-July 2021, while earnings continues inclining to $209.6 by late-July 2021. From there until recently, valuation steadily declines to 20.7x, while earnings inclines to $216.1 by mid-October 2021.

2. Well, we’re waiting.

Even though some companies have been managing through supply chain chaos, it is still on everyone’s mind. Bloomberg’s Transcript Analyzer shows that S&P 500 company executives have uttered the words “supply chain” about 3,000 times so far this year (which is a record, for those of you keeping score). The question is for how much longer we’ll have to deal with the bottlenecks. While these should gradually improve over the next few months, we aren’t going to hold our breath. A typhoon in Asia has backed up ports in the region, and many of those ships will be headed to log-jammed U.S. ports once they set sail. It probably makes sense to do your holiday shopping early this year….

This chart shows the number of containerships waiting and in port in five major global ports as of October 18, 2021. In Hong Kong/Shenzhen/PRD, there are 109 ships waiting and 68 in port. In Shanghai/Ningbo/Zhoushan, there are 60 ships waiting and 76 in port. In Singapore, there are 41 ships waiting and 39 in port. In LA/Long Beach, there are 35 waiting and 28 in port. Finally, in Savannah, there are 25 waiting and 6 in port.

3. Re-fi-ing De-Fi. 

The first U.S. listed Bitcoin-linked ETF is now the most successful launch in exchange-traded fund history. The ETF gained over 1 billion of assets in just two days, beating the largest Gold ETF’s 18-year-old record. The ETF also saw volumes over $1 billion for each of its first three trading days, more than stalwarts like the silver ETF, the Dow Jones ETF or the ARK Innovation ETF. Perhaps unsurprisingly, Bitcoin rallied to all-time highs.

4. [Some] central banks are getting antsy. 

Not all central banks are like the Federal Reserve. The Bank of England is the most notable central bank to signal that a rate-hiking cycle might be imminent. At a conference on Monday, Governor Bailey said that “We, at the Bank of England, have signaled, and this is another such signal, that we will have to act” to fight inflation and to keep inflation expectations anchored. That is not exactly subtle, and a far cry from Jerome Powell and Christine Lagarde’s much more balanced and patient tone. Short-term rates in the United Kingdom were already soaring, and Bailey is only adding fuel to the fire.

This chart shows the U.S. 2-year Treasury yield and UK 2-year Gilt from January 2019 to mid-October 2021. In early 2019, the U.S. 2-year Treasury yield measured 2.4%. It slightly climbed from there yet began its ascent at an absolute high of 2.6% in mid-January 2019. It then fell to 1.4% by August 2019. Meanwhile, the UK 2-year Gilt began at 0.7%, falling at a shallower rate to hit 0.4% by August 2019. Both rates hovered respectively prior to mid-February 2020. At this point, the U.S. 2-year had a dramatic nosedive to 0.4% by mid-March 2020. The UK 2-year also fell, but much less dramatically, reaching 0.05% at the same time. The U.S. 2-year kept falling to an absolute low of 0.1% in May 2020, whereas the UK 2-year fell into the negatives, hitting an absolute low of -0.2% by the end of 2020. The U.S. 2-year stayed near that level until mid-June 2021 when it felt a slight increase to 0.2%. The UK 2-year felt this slight pop a bit earlier, reaching 0.08% in early March 2021.   For the U.S. 2-year, from June 2021, it hovered near 0.2% until the end of September when it began a modest ascent. As of late, it marks 0.4%. For the UK 2-year, from March 2021, it hovered near 0.08% until early August when it began a steeper ascent than the U.S.. As of late, it tops the U.S. and marks 0.7%.

Notably, futures markets are starting to sense a “policy error.” They suggest short rates in the UK will be lower in two years than they are in one year. That means that the Bank of England might cause a growth slowdown that they could try to reverse through interest rate cuts. You don’t have to be a central bank wonk to know that it’s bad news if the market is already pricing cuts before you have even hiked. Bailey admitted that central banks cannot fix supply chain bottlenecks with their tools, but he is so concerned with inflation he is willing to risk a growth slowdown to combat it. We still believe the Fed will remain patient, but if we did see pricing like this in the U.S. yield curve, it would likely lead to turbulence for risk assets.

5. Crunch time in Washington. 

Democratic lawmakers are busy hammering out the details of President Biden’s economic agenda. While there still might be a long way to go to a final bill, there have been some perceived shifts that are a positive for markets. Based on recent press reports, markets now think materially higher corporate tax rates are all but off the table. According to predictit.org, there is now just a 10% chance that the corporate tax rate will be raised to above 24.5%, down from an almost 50-50 chance earlier this week. In fact, that market suggests an 80% chance that corporate taxes don’t change at all. Interestingly, the perception around the amount of spending hasn’t changed. There is still a long way to go, and there is a chance that other tax provisions (like changes to global intangible income taxes) are more onerous to split the difference, but the buzz from Washington this week was a positive for markets.

All market and economic data as of October 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

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