Inside the Broker - Stock indices pull back from record highs again
Inside the Broker
Stock indices pull back from record highs again
On Monday we saw a continuation of a sell-off across major stock indices which began early last week. After hitting record highs, both the S&P 500 and NASDAQ 100, along with all other US and European stock indices, have pulled back quite sharply. This has led some traders to consider that the equity market rally could have run out of steam for now. The major global indices have all come a long way since the markets first reacted to the pandemic in March and April 2020. There’s no doubt that investors have been pricing in a lot of good news. The overall attitude has been that economies across the globe are bouncing back sharply as vaccination programmes roll out and people get back to working and living as they did pre-pandemic. But there are concerns that we’re getting ahead of ourselves. There’s a feeling that we may have seen the best of the growth bounce-back, and countries such as England are unlocking too early. There are fears that even with vaccines, coronavirus cases will continue to grow, and this will dampen economic activity, even if the virus is less fatal. It’s certainly unhelpful when double-vaxxed workers get pinged and forced to isolate, as our Great Helmsman, Boris, himself found out.
It’s not just coronavirus which is weighing on sentiment. There are fears that the vast dollops of monetary and fiscal stimulus that have been shoved into the global economy over the last sixteen months are pushing inflation up to dangerous levels. On Friday, data from the University of Michigan showed that consumers expect prices to jump 4.8% over the next year, the sharpest increase since the summer of 2008. This follows on from US CPI which came in at a 5.4% for June, also rising at its fastest pace since 2008 and well above the +4.9% expected. Central bankers have been trying to shift the inflation needle since the Great Financial Crisis of 2008/9. Bear in mind, the world is up to its collective neck in debt and that will be a drag going forward. Some say, don’t worry as it’s affordable when interest rates are low. But if the jump in inflation proves to be persistent then central banks will be forced to act. The hope is to inflate debt away while keeping monetary policy loose. That’s why the Federal Reserve continues to insist that inflation is transitory, which suggests they won’t have to raise interest rates anytime soon. Luckily, weakness in the jobs market is helping. They’re using the shortfall of over 6 million jobs from pre-pandemic levels as their excuse not to raise rates. But, Federal Reserve Chairman, Jerome Powell may be cracking. Last week he testified in Washington on monetary policy. He blames the ‘shock’ of the economy reopening for inflation soaring above the Fed’s 2% target, and insisted the central bank wasn’t happy with it. He went on to say that if the rise in inflation proved persistent, the Federal Reserve would have to ‘re-evaluate’ the risks.
Monday saw the yield on the key US 10-year Treasury note fall below 1.20%, a particularly sharp move of 10 basis points from Friday, and its lowest level since early February. Yields fall when bond prices rise, and bonds prices rise when people buy them. Previously, we’ve seen equities and bonds go up in tandem. But the fact that equities are falling as bonds rise would suggest a move out of a riskier market (equities) to the relative safety of bonds. What’s behind this move? Initially it was explained away as a positive sign as investors viewed the current rise in inflation as transitory, going along with the US Federal Reserve. But it can simultaneously point to expectations of lower growth, or an economy weaker than previously expected, especially with so much liquidity in the market in the form of cheap money. At its most extreme, the rally in bonds can be viewed as a ‘flight to quality’ whereby investors reduce their risk to the uncertainty of volatile, and historically expensive equities, to the relative ‘calm’ of the US Treasury market. If so, we could be witnessing the start of a tricky summer.
We’re into the second week of the second quarter earnings season. Last week was broadly positive for the banking sector. But a succession of better-than-expected numbers failed to put a fire under big players like Goldman Sachs and JP Morgan. Both banks saw their share prices end lower on the week. We have some big players reporting this week including IBM, UBS, Philip Morris International, United Airlines, Chipotle, Netflix, Johnson & Johnson, Coca-Cola, Texas Instruments, Intel, Twitter and American Express, Honeywell, Kimberly-Clark. But it’s the following week which should garner most interest as we have results from Big Tech.
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