Yesterday, we showed how markets appeared to be pricing in relative calm ahead of a series of events that each had the potential to move markets significantly. As of now, with the S&P 500 (SPX) and NASDAQ 100 (NDX) Indices both up about 0.25%, the volatility markets appear to have been correct. It is interesting to see a relative yawn after blowout earnings from Apple (AAPL) and Facebook (FB) – the largest index component and a top 5 counterpart, – a continued commitment to dovish monetary policy from Federal Reserve Chair Powell, and a State of the Union address from President Biden that offered few surprises. What gives?
For starters, neither Chair Powell nor President Biden (I list them in order of direct influence upon markets), said anything particularly new. Markets move more when they are surprised. The Fed remains committed to easy money until or unless they deem inflation to be something other than transitory and/or full employment is achieved. That’s not new. The President wants a robust infrastructure package and higher taxes on the highest earners. That’s not new either. With neither leader offering substantially different guidance or unanticipated policy hints, investors could largely ignore their comments. The takeaway from the FOMC and SOTU was if you already like your investments, you have no immediate reason to change that view, but you also have little impetus to add to them.
The news on the earnings front was different. AAPL and FB continued to fill the mega-cap earnings bingo card with better than anticipated results. Leaving aside the obvious question of how did so many smart and well-paid analysts get their estimates so wrong, this continues to reward investors who have pushed the leading tech stocks to enormous market capitalizations. Yet only FB is being truly rewarded for its efforts. It is up over 6% while AAPL is up less than 1%. A possible answer to that performance differential helps explain equity markets’ lack of enthusiasm.
AAPL noted that the ongoing semiconductor shortage could hurt earnings by as much as $4 billion in the third quarter. If there was any company that seems too big to be hindered, it’s AAPL. They’re the biggest customer for chips out there – companies should be rushing to meet their demand first, no? If they can’t get the chips they need, who else can? Apparently not Caterpillar (CAT), who says they may not meet 2021 end user demand, or Ford (F) who expects as much as a $2.5 billion impact to its bottom line.
It may be that equity investors are coming around to what commodity traders have known for weeks. Demand is exceeding supply. Anyone who understands basic economics knows that if demand increases faster than supply, prices rise. Semiconductors are not traded on commodity exchanges, but copper, lumber, corn and soybeans – to name a few – are. They are all up sharply over the past few months. We can attribute the rises in the first two commodities to sharply increased demand for housing. To what do we attribute the rises in the latter two? Sharply increased demand for eating?
Another basic economic tenet has always been that inflation is primarily a monetary phenomenon. When gold was money, there was a startling bout of inflation in Spain from the late 15th through early 17th centuries, as the influx of gold from their New World colonies flooded the market in Europe. The supply of money rose sharply, meaning the consumers required more of it to purchase the same amount of goods. When money became paper, bouts of inflation sometimes resulted when governments printed ever-increasing amounts of it. Is it all that surprising that the phenomenal amounts of money being created by the Federal Reserve and given to individuals by the Federal Government might result in inflationary pressure?
For many, the answer is yes. For the better part of 13 years, we have seen an almost relentlessly accommodative Federal Reserve. Throughout that period, we have seen significant appreciation in financial assets, but little follow through in measures like the Consumer Price Index (CPI) or Personal Consumption Expenditures (PCE). That led us into a period of price complacency. Investors learned not to fight the Fed, while consumers faced few pressures otherwise. That narrative may be changing, and that could be what is holding stocks back somewhat.
The Fed continues to view the current inflationary pressures as transitory and resolves that they will not adjust monetary policy until they see sustained, non-transitory inflation. The difficulty with that approach is that it is incredibly difficult to distinguish transitory from non-transitory inflation. This morning’s release of the GDP Price Index calls that into question. It rose 4.1% vs. an expected 2.6%. On the surface, that is worrisome. It becomes less worrisome when compared to the Core PCE of 2.3%, vs. an expected 2.4%. That is right in the Fed’s wheelhouse. Putting aside the standard inflationary complaint that we still need the items in non-core inflation like food and energy, the Fed can still stand pat – at least for now.
Yet it may be that investors are beginning to worry. Not too much, obviously, because markets are higher, but something is holding them back today. Are investors getting concerned that the transitory price increases are becoming something more concerning? Are they unhappy because higher commodity prices and nagging supply chain issues could affect corporate earnings? Quite possibly. If the commodity cycle eases, vindicating the Fed’s approach, this will turn out to be another in a long series of temporary concerns that investors have chosen to look beyond. If not, and the Fed is forced to act more quickly than investors are anticipating, don’t fight the Fed takes on a completely different meaning.
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