Week Ended October 29th, 2021

Let’s start this week by looking at the news that drove financial markets, and then E-MorningCoffee will drill down into performance by asset class. Markets endured a fairly eventful week as far as:

• corporate news plus a slew of earnings

• US 3Q21 GDP release (first cut) and personal income for Sept

• the UK current economic update and 2022 budget

• an ECB monetary policy decision and inflation in the Eurozone, and

• a possible compromise on the Biden social fiscal plan, to which the infrastructure plan is linked.

The week ended with global leaders headed first to the G20 summit in Rome, and then on to Glasgow for the beginning of the UN-sponsored COP26 (environmental) conference which begins on Sunday.

Summary of market-moving news this week

Earnings

Earnings continued to flow this week in the US and Europe, with much of the attention Stateside focused on the FAMAG names. FB (flat W-o-W) was up first and beat consensus expectations but identified some weakness in advertising spend, perhaps not surprising following results the week before of SNAP (-4.6% W-o-W) which had the same issue. TWTR (-14% W-o-W) also released decent results last week but had exactly the same issue as FB and SNAP. GOOG (+7.0% W-o-W) sited similar concerns on its YouTube platform. FB, SNAP and TWTR also suffered from the change in iOS 14 (AAPL) privacy settings that was implemented in the second quarter, not a factor that really affected GOOG since it has its own Android operating system. Advertising spend is the issue that caught my eye though. Lower advertising spend reflects the fact that companies are reducing advertising on social media because they simply can’t produce and deliver enough products to satisfy demand. In other words, why should a company spend money advertising a product when all of its products are being sold anyway (without advertising)? This is “supply chain disruption” at work, a key contributing factor to the supply-push inflation the global economy is currently experiencing. Turning back to the FAMAG names, cloud (Azure) was a big driver for MSFT’s (+7.3% W-o-W) strong beat on the top and bottom lines, as the company had across-the-board stellar results. The week ended though for the FAMAG names on a bit of a downer, as both AMZN (flat W-o-W) and AAPL (+0.7% W-o-W) missed analysts’ consensus expectations for the quarter, with the former identifying labour issues (can’t hire enough delivery drivers and increasing wages to attract workers) and the latter highlighting supply chain disruptions. If you own either of these stocks, the good news is that they bounced well off their intraweek lows which occurred Friday morning as investors were digesting results.

Other than the FAMAG and other corporate earnings announcements, the week started with news regarding two deals which turned out to be good for at least three of the four companies involved. Hertz (HTZZ) announced Monday pre-open that it had reached agreement to buy 100,000 EVs from TSLA, which sent both companies’ stocks up sharply on the week (HRTZ +25.6% W-o-W, TSLA +22.5% W-o-W). The second deal was actually not a deal, but rather an acknowledgement by PayPal (PYPL) – to the relief of its shareholders – that it was not going to pursue the acquisition of Pinterest (PINS). PYPL was down -3.2% W-o-W, better than expected given backdrop, whilst PINS plummeted -23.1%. I’m glad I own PINS!

Now that we are more than halfway through the S&P 500 3Q earnings season, it is fair to say that this period has had two interesting characteristics so far. Firstly, there are still plenty of companies beating analysts’ consensus expectations on the top and bottom line. Secondly, companies that are at or near all-time high valuations are being heavily scrutinised if their guidance has any deviation from the growth needed to support their valuations. These deviations, when they occur, seem to be mainly related to supply chain and labour issues. Even slight revisions to guidance make some of the newer tech “high flyers” and high P/E stocks particularly vulnerable.

And about that name change of Facebook to Meta….

You can find more about last week’s earnings for S&P 500 companies at the Refinitiv website here.

US GDP 3Q2021 (first estimate)

The Bureau of Economic Analysis (BEA) released its first estimate of 3Q2021 US GDP, which was 2.0%, well below consensus estimates of 2.7%. The BEA press release is here. The contributors to lower-than-expected 3Q21 GDP seemed to mainly be an increase in inventories (supply chain issues…again) and lower-than-expected consumer spending on goods (although services were robust). The latter issue was reiterated the following day with the release of personal income, which declined in September. The question becomes is this simply an adjustment period or the “new normal”? Markets don’t seem worried although the yield curve is flattening, perhaps a reflection of expectations of slower US economic growth ahead. Oh....and the equity market doesn't care!

UK Budget

In the UK on Wednesday, Chancellor of the Exchequer Rishi Sunak released the 2022 UK budget and a report on the state of the UK economy, which pointed towards better-than-expected UK economic growth for the current period (expected 6.5%) and the year ahead (6% GDP growth in 2022). Inflation is also expected to remain above target 2%, increasing to 4% in 2022. As a result of better-than-expected growth, tax revenues have been and should continue to be higher-than-projected resulting in some increases in government expenditures and no significant further tax increases for the year ahead. If you want to dig deeper, see “Budget and Spending Review – October 2021: What you need to know” on the official UK government website. The forecast means the government is projected to borrow £60 billion less than was forecast in April, which caused Gilt prices to skyrocket. The yield on the 10-year Gilt plummeted 22bps to 1.02% on Thursday after the budget was presented. The current inflationary environment and strong growth rate make it more likely that the Bank of England will raise its overnight bank deposit rate before the end of the year, making it the first of the major developed market central banks to do so.

ECB monetary policy decisions

The ECB announced on Thursday that the overnight bank rate and quantitative easing programmes (both the APP and PEPP) would remain as they are in the Eurozone for the foreseeable future. The press release is here. This means that the governing board, led by Christine Lagarde, has also concluded that inflation – which is clearly running hot in the Eurozone – will be transitory. Sound familiar? The following day, Eurozone inflation for September was released and it was not pretty (3.4%), although this depends on your perspective. On one hand, this is not terrible in an economic bloc characterised by more worries since the GFC over deflation than inflation, especially – as the ECB believes – if the inflation proves to be transitory. On the other hand, hitting a 13-year high in inflation is not something that should be taken lightly given the supply-push inflationary pressures which will not subside overnight, especially in a region in which inflation has hardly existed for years.

US fiscal plan: infrastructure and the social package

This is taking shape, with President Biden saying Thursday that he thought a $1.75 billion fiscal package (the social portion) would get Democratic support. This would be approved along with the infrastructure plan that is being held hostage whilst the social plan has been debated rigorously within the Democratic party. Aside from expenditures on climate, childcare & education, and healthcare, the billionaire tax was dropped (how in the world would that work anyhow?) and will be replaced by two additional marginal taxes of 5% on incomes above $10 million and 3% more on incomes above $25 million. I do feel sorry for those folks, meaning the 0.02% of Americans who will face these income tax surcharges (sarcastic remark FYI). There is also one corporate tax provision which would require all US companies to pay a minimum tax of 15%. Based on what I have read so far, this smaller US fiscal plan (should it be approved) – in conjunction with a robust outlook for the UK – means that neither capital gains nor corporate taxes are likely to be increased in 2022, positive news for equity investors.

G20 / COP26

Many of the leaders of the world’s largest countries will be heading to a G20 meeting in Rome over the weekend (Oct 30-31, summit link here). This will be followed by the COP 26 UN-sponsored climate change conference in Glasgow, co-hosted by the UK and Italy, that starts on Sunday, October 31 and runs through November 12. This is an important event as the world discusses the requisite steps to reduce emissions so that the rise in the average global temperature can be capped at 1.5C. You can find the official link to the COP26 conference here (worth reading), and an easy-to-understand and concise summary of the COP26 meeting and its objectives on the BBC website here.

The Financial Markets this Week

Global equities struggled most of the week but all of the developed markets indices I track somehow ended the week with their heads above water. The Shanghai index (-1.0% W-o-W) and the MSCI EM index (-2.2% W-o-W) were both negative, whilst the S&P 500 (+1.3% W-o-W) delivered the best return across global indices.

State-side, the NASDAQ Composite took the crown for the week as UST bond yields stabilised and economic growth expectations moderated. As discussed already, earnings were generally positive although a few of the much-watched FAMAG stocks delivered weaker-than-expected results, with all cautioning on guidance as a combination of supply-chain disruptions and labour shortages are likely to continue to negatively affect both top line growth and margins. Even so, the NASDAQ Comp returned 2.7% for the week, much better than the value-proxy Russell 2000 (+0.3%) and the cyclical / reflation DJIA (+0.4%).

Treasury bonds bounced around much of the week, but generally were better bid in intermediate and longer maturities with the yield on the 10-year UST falling 11bps to close the week yielding 1.55%. As we have seen now for several weeks, the shorter end of the curve felt the most pressure, with the 2-year UST yield remaining flat W-o-W (but down from intraweek highs) to close 0.48% even as longer maturity USTs were rallying. This performance can signal two things. Firstly, bond investors at the shorter end are continuing to signal that the Federal Reserve should probably act sooner rather than later as opposed to sticking with its dovish “inflation is transitory” narrative. In this respect, I am not convinced that current inflation is in the hands of the Fed (although they certainly started it), because many of the pressures are supply-push inflationary factors over which the Fed is largely impotent. Secondly, the flattening yield curve reflects moderating expectations regarding future US economic growth, not surprising at all given the below expectations release of 3Q21 GDP (first cut) and September personal income data.

As far as government bond yields in other developed markets, most were stable on the week with the exception of the UK, where yields on intermediate and longer maturity bonds plummeted due to the 2022 supply outlook (discussed in news section above).

In corporate credit, credit spreads were fairly stable although yields improved in line with the slight improvement in yields in the underlying UST market. The high yield market continues to show resiliency, and issuers are continuing to serve up new primary product to hungry investors. It feels to me like the best of times for corporate credit!

As far as safe haven assets (aside from USTs), gold continues to go nowhere fast, down slightly on the week. The US Dollar is another matter though as the greenback continues its slow but steady rise. The Japanese Yen is going the other direction, weakening further as the US Dollar strengthens (normal), but also influenced by domestic concerns regarding growth.

The price of oil levelled off this week finally, with WTI oil closing the week at $83.30/bbl (-0.5% W-o-W). I suspect this might reflect moderating economic growth in the US, although many pundits expect another leg up for oil prices, some saying we could see $100/bbl before it’s all over. This is hard to call, and time will tell. Lastly, Bitcoin is increasingly becoming a store of value – at least during this period – as other financial assets show fatigue. The benchmark cryptocurrency closed Friday at $62,228, +2.5% W-o-W. It is putting returns on other asset classes to shame.

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