News & Insights

The following has been compiled from information and comments provided by the investment professionals of Frost
Investment Advisors:

Against the Odds…

A few months ago (five and counting) the markets faced an impossible dilemma, having sold off at a record pace with near-zero upside potential given the pandemic spread, home quarantine and vaporized earnings visibility from Wall Street.  Fast forward to the present, and the market’s break-neck recovery has also set an historic tone, both in speed and magnitude.  With last Friday’s close, and depending on today’s market moves, the month of August is on track to reverse what has typically been a negative month (at least since 1980) while also registering a record-setting recovery from the March lows through last Friday of 57 percent.  As for year-to-date S&P performance, a positive and respectable return of around 8 percent – quite the change in attitude and latitude.

As to the market’s rally, the disparity between the haves and have-nots continues.  The fifth straight week of positive returns for both the S&P and NASDAQ has been mostly driven by a handful of stocks, sectors and asset classes.   Momentum is pushing the broader indexes (which are large cap growth-centric) higher, while the cyclical and smaller company stocks continue biding their time, awaiting investor interest.   Whether the next few months or the upcoming election change market trends remains to be seen, but if the economic goal for next year is to broaden the work force, increase job creation and rebuild the economy, then the cyclical companies within the materials, industrials, energy and financial sectors should get increased investor attention.  For now, the disparity between S&P Growth and S&P Value continues to widen, sitting at nearly 36 percent on a year-to-date basis.

The story for the fixed income markets is pretty similar in that while there has been a lot of investor attention, bond yields continue to reflect both the impact of cash inflows and a very accommodative Fed.  Today’s 30-year bond yield sits at a yield of around 1.5 percent, with shorter-term Treasurys holding firm with positive sub-1 percent nominal yields.  If you add back inflation, the nominal yields begin looking negative in real-terms.

The likelihood of any significant change in the fixed-income market over the next year or two is unlikely given Fed comments last week relating to its monetary policy outlook and management.  Fed Chair Powell announced several changes that will likely mean a continued “dovish” interest rate policy for the foreseeable future (and maybe further).  Powell noted that “a robust job market can be sustained without causing an outbreak of inflation” and that inflation didn’t rise as anticipated when unemployment fell to historically low levels.  The take-away was that the FOMC would not increase rates solely on the basis of anticipated inflation.  Their stated goal at this point is to change their current static target of 2 percent to a rolling 2 percent target for inflation. 

And while the markets continue to be more forward-looking than the news headlines, the continuing question is whether the markets are overly optimistic.  The data thus far continues to be supportive of a grinding recovery for the economy.  However, as we’ve noted before, the big leave-behind so far has been the job recovery.  Progress has been made, albeit by way of a slow upward weekly slog (which is likely to continue for months to come).  Through last week, continuing unemployment claims had improved slightly with only 14.54 million without a job (versus the prior week number of 14.758 million), while initial new claims continued to come in above the 1 million level.  Interestingly enough, despite the levels of unemployment (and courtesy of government unemployment subsidy checks and improvement in the continuing unemployment rolls), personal income actually surprised to the upside in July, up 0.4 percent versus an expected fall of 0.2 percent.  Add back a slightly improved consumer outlook reading from the University of Michigan index (74.1 vs. 72.5) and it’s still too early to discount future consumer support as the economy rebuilds.

In terms of other supportive news starting September’s pre-Labor day week, there were several headlines that continue to stimulate equity market interest:

• Corporate earnings continued to surprise to the upside for the second quarter, and expectations are that this trend continues and accelerates into 2021 (from a very low trough in 2020).
• Durable goods orders were up 11.2 percent in July (versus estimates of 4.3 percent), following a 7.7 percent increase in June.  One of the key boosters was a 35.6 percent increase in transports (cars and parts).  The really good news is that core orders (ex-transport) are now in line with pre-pandemic reports.
• Fed District Manufacturing reports from Richmond and Kansas City were both positive last week, with both districts reporting their indexes have recovered back to late 2018 levels.  Chicago was off slightly, but the weakness was mostly due to a fall in inventories.  Good longer-term news is that inventories need to be replaced, which should lead to an improving manufacturing outlook over the next few months.  There was also a slight downturn in this Monday’s report from the Dallas Fed, as the state’s production index fell slightly from July to August (16.1 to 13.1), breaking a three-month improvement for the state’s manufacturing outlook.  The upside was that the future company outlook and general business activity indexes both surged.  Positive signs may be ahead.  The company outlook measure reflected a move from 18.7 to 27.8, with the general business activity rising from 10.6 to 20.4 on the index.

One final note for this week is that there is going to be a noticeable change as of today in the composition of the Dow Jones Industrial Average, as three “old industry” stocks are moving from the index to be replaced by three “new industry” constituents.  Exxon Mobil, Raytheon Technologies and Pfizer will be moving out of the 30-stock index to be replaced by Salesforce, Amgen and Honeywell.  These moves coincide with Apple’s 4-for-1 stock split.   The newly reweighted index will reflect some changes, with the most significant being a slight drop in the technology sector weighting, which will fall at the start of trading (by 3 percent) and an increase in health care (4 percent).  The overall impact to the Dow Jones Industrial Average will be a slight decrease in tech momentum, at least for now.  At a 24 percent weight, it’s still significant.