by | August 9, 2021

Pity the poor investment manager left to mind the store while colleagues head to the beach. Those now in charge may be superficially comforted by rising equity prices and generally calm market conditions. But beneath the broad index level, the market is see-sawing back and forth, wrong-footing active managers. The ride for those at the wheel is prone to whiplash.

Consider the past week. Initially, bond yields fell to multi-month lows, propelling utilities to the top of the performance tables. On Friday, however, a stronger-than-expected US employment report abruptly changed the market dynamic. Bonds sold off, with real rates rising on healthy jobs growth and wage gains, including an upward revision to job creation in the prior month. Cyclical, financial and value-oriented stocks got a boost on Friday from a steeper yield curve, while utilities slumped. 

Last week was a microcosm for 2021. At the broadest level, equity markets have advanced steadily this year. But beneath the surface, rotation and counter-rotation are furiously alternating. Investors charged with picking relative winners and losers between cyclicals and defensives, value and growth, quality and junk surely have sore necks from the jarring reversals of style and sector performance. 

A key underpinning for global equities this year has been corporate profits, which have surged over the past six months. With over three quarters of US firms having reported earnings for the second quarter 2021, the percentage of ‘beats’ is topping 85%, a new record. Market advances may confound the skeptics and doomsayers, but equity indices rarely slump when firms are piling up profits at this pace.

To be sure, companies that have underperformed expectations have been punished, in some cases severely. And, as George Magnus points out in a companion piece this week, China’s repeat interventions to rein in companies deemed to be insufficiently compliant with Beijing has also resulted in sharp setbacks for a handful of Chinese names. 

Many observers have been puzzled that global equity markets remain unperturbed by surging Covid-19 (Delta) infections, hospitalizations, and deaths in the US and elsewhere. After all, the latest data show that the US Covid surge has taken new infections back to their shockingly high February levels of around 100,000 a day.

But perhaps investor’s nonchalance to the latest pandemic wave is not surprising. Presumably, their attitude reflects confidence that economically damaging lockdowns will not be part of the 2021 policy response. After all, in the US the spread is fastest in states with low rates of vaccination—precisely those most opposed to restrictions on social gatherings, mobility and economic activity. States with higher vaccination rates are reimposing minimal restrictions, such as mask requirements, but appear unlikely to impose more draconian measures that would undermine the economic and earnings recoveries. 

Meanwhile, the latest positive economic data are shortening the timeline for central bank patience with higher inflation. Futures markets now anticipate the first UK rate hikes early next year. Gaps are opening in the Fed’s policy rhetoric, with Fed Governor Clarida and Dallas President Kaplan the latest central bankers to suggest that tapering, or other adjustments, may be required sooner than previously thought. At the ECB, the usual hawkish suspects (e.g., Bundesbank President Weidman) are making the case for ending pandemic emergency programs, even if the latest EU growth and inflation data offer less compelling evidence for early tightening.

Over the remainder of August, market participants will focus on inflation data and the Fed. Month-on-month increases in US consumer prices are expected to have peaked in July, but if the data show a broadening of price pressures across sectors of the economy, the results may prove problematic for Fed Chairman Powell’s ‘transitory’ mantra. At month’s end, the Fed’s Jackson Hole conclave looms large as an opportunity for the US central bank to convey its exit strategy from its current accommodative stance.

Investors have reasons to pay heed. The earnings season is ending, removing a flow of supportive news. The pandemic may not yet force a reassessment of second half growth, but there are few reasons to expect Covid relief soon. US growth remains underpinned by job creation and rising household incomes, as well as signs that Congress will pass a trillion-dollar infrastructure bill. But a sluggish labor market supply response—as evidenced by little movement this year in the depressed labor force participation rate—serves as a reminder that bottlenecks remain potentially problematic for growth and inflation. Lastly, markets are anticipating the beginning of the end to central bank largesse.

In short, whiplash-weary investors may not get much respite in the weeks ahead. Perhaps it is time for neck braces. Or time to head to the beach.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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