The 1% Move Report

Wealth Management — August 18, 2021

• US stocks traded lower on Wednesday as the S&P 500 declined 1.1% to close at 4,400. With the sell-off, the index is now up 17.1% year to date.
• While US equity markets started out the week on a strong note, with Monday's rally seeing the S&P 500 move higher for a fifth consecutive session to set a fresh all-time high, volatility has returned in recent sessions with the index posting back-to-back declines. Cyclical sectors have underperformed as markets move past a strong second quarter earnings season and now focus on a number of potential near-term headwinds. Among the catalysts potentially responsible for this week's slide: rising Delta-variant cases in the US that could pause the "re-opening" in the economy, speculation that the Federal Reserve could move closer to tapering its bond purchases, and modestly disappointing economic data with several releases missing consensus forecasts in recent days. 
• Ten of 11 S&P 500 sectors were lower on the session, with Consumer Discretionary (+0.2%) and Utilities (-0.5%) outperforming the broader market, while Health Care (-1.5%) and Energy (-2.4%) lagged. 
• Rates were near flat across the curve, with the 10-year Treasury yield at 1.26% as of the 4 p.m. equity market close. Gold was also flat on the day while WTI oil was lower to under $65 per barrel. The US dollar was modestly higher on the trading session, as measured by the US Dollar Index. 

US markets declined on Wednesday as the S&P 500 fell 1.1%. Equity markets were quiet throughout much of the session but a late day sell-off materialized which saw the S&P 500 record its first 1% sell-off in nearly a month. While the index had rallied for five consecutive sessions to close at a new all-time high as recently as Monday, a now two-session sell-off has seen the index fall nearly 2%. Several catalysts may be contributing to this week's reversal. First, growing concerns over the recent rise in Delta-variant COVID cases across much of the US likely has contributed to the sell-off in cyclical assets as markets ponder whether the health crisis could again disrupt economic growth. Additionally, in recent weeks markets have focused on a potential shift in Federal Reserve policy as several Fed governors have suggested the central bank should consider tapering its asset purchases in the coming months - Wednesday's release of the July FOMC minutes appeared to corroborate this shift and this may have weighed on equity markets Wednesday afternoon. Finally, this week's economic data releases have been modestly disappointing, with Tuesday's retail sales and Wednesday's housing starts report both missing expectations. These potential risks notwithstanding, equity markets were likely due for some consolidation regardless of news flow given the extent of recent gains - earlier this week the S&P 500 eclipsed 100% rally off of last year's lows, and the index is still up more than 17% on the year to date. Looking ahead, Thursday will see the weekly jobless claims report and next week focus likely returns to Washington D.C. as the House of Representatives is expected to return to discuss infrastructure and the budget. 

Record stimulus and a stronger-than-expected US reopening have accelerated the shift from early to mid-cycle, lifting equity markets to new all-time highs. The continued economic momentum in global trade, manufacturing, corporate earnings, and housing have set the tone for strong US economic growth; however, this backdrop has been increasingly priced into markets. Index-level valuations peaked at more than 22x forward earnings and history suggests valuation multiples will trend lower as earnings improve, supporting our base case June 2022 target of 4,225 for the S&P 500 and our bull case of 4,450. With higher expectations and a move into mid-cycle, investors should upgrade their portfolios by dialing back extreme positioning and allocating more exposure toward high-quality cyclicals and growth at a reasonable price. With a potential long-term infrastructure bill in progress, continued Fed accommodation, and the unleashing of pent-up demand for services-related spending, the US faces a potential favorable outlook for economic growth with 7%-8% real GDP this year and inflation possibly rebounding to a 2.5%-3% range over the coming years. However, optimal navigation of this new business cycle will require care as Treasury rates appear likely to move higher toward 2% in the next year, creating a headwind for long-duration assets. With regard to stocks, our preferences for quality and valuation support warrant allocating to international stocks with less expensive valuations, and cyclicals, including financials, which should benefit from the steeper yield curve. Dollar weakness is likely to continue as policy choices are debasing and relative growth outside the US becomes more compelling as the rolling global reopening continues. In fixed income, the challenge is two-fold: Generating sufficient income, while also preserving capital, requires a diversified and active exposure, with our preference toward a mix of high yield credit, preferreds, leveraged loans, asset-backed securities, including select mortgage-backed, and dividend-paying stocks. Real assets such as gold, infrastructure, and real estate present an attractive opportunity as a portfolio ballast for income generation and as an inflation hedge.

Market data provided by Bloomberg.

Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.

NASDAQ Composite Index: A broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market.

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

US Trade-Weighted Dollar Index: A weighted average of the foreign exchange value of the US dollar against a subset of the broad index currencies that circulate widely outside the US.