Last week was filled with flourishing U.S. economic data and solid corporate earnings, including blowouts by some of the world’s largest technology companies, is in the books, yet stocks still managed only a mixed performance, feeding fears that market participants have already priced in a post-pandemic economic boom.
Saira Malik, Chief Investment Officer for Nuveen’s $420 billion global equity division said that the way the markets are behaving has to do with investor concerns over whether the easy money has been made.
“A lot of easy money has been made but there is still scope for gains. Investors, however, will need to be more selective, focusing on companies and sectors more likely to top rising earnings expectations,” Malik said.
The past week was hardly a disaster. The benchmark S&P 500 index and the tech-heavy Nasdaq Composite both traded in record territory, but no breakouts were to be had. The Dow Jones Industrial Average ended the week down 0.5%, while the S&P 500 was virtually flat and the Nasdaq Composite fell 0.4%.
Monthly performance was nothing to sneeze at, with the S&P 500 rising 5.2% in April for its strongest month since November. The Nasdaq’s 5.4% rise for the month was the strongest since December while the Dow rose 2.7% in April.
The week ended with data that showed a 21.1% rise in personal income in March, fuelled by fiscal stimulus checks, and accompanied by a 4.2% jump in personal spending. It followed an estimate of gross domestic product (GDP) data that showed the U.S. economy grew at a rapid 6.4% annual pace in the first quarter of 2021.
And the strong economic readings are almost certain to continue in the week ahead, with the Institute for Supply Management releasing its manufacturing index for April today, Monday, May 3, 2021, and its April services sector gauge on Wednesday. The Labour Department will release the May jobs report on Friday with some economists seeing the potential for nonfarm payrolls to rise by more than 1 million.
Quincy Krosby, Chief Market Strategist at Prudential Financial said that questions about whether this is “as good as it gets” are understandable, given that booming data, particularly for purchasing managers indexes, often herald monetary policy tightening by the Federal Reserve that leads to a slowdown. Prudential Financial has $1.721 trillion in assets under management.
But the Fed remains committed to allowing the economy to run hot, she noted.
On Wednesday last week, Federal Reserve Bank Chairman Jerome Powell reiterated that it remains too early to even consider talking about pulling back on the central bank’s extraordinary monetary stimulus measures, arguing that signs of inflationary pressures remain “transitory.”
“Whereas some employers are complaining about labour shortages, the jobs market is still far from tight as the economy continues to recover from the pandemic,” Powell said.
A Fed on hold means well for interest-rate-sensitive stocks, particularly those tied to the consumer as the economy continues to reopen, Krosby said.
Travel and leisure stocks and some other consumer-oriented parts of the market “can still do extremely well. Add in President Joe Biden’s infrastructure spending proposals and there is room for industrials as well as clean energy names, which have already done well, to benefit,” Krosby said.
Malik is also positive on consumer-oriented companies, while industrials are set to benefit from continued economic growth and infrastructure spending. She also said that financial firms should be poised to beat earnings expectations and should benefit from higher interest rates as inflation pressures push yields higher.
Malik is also bullish on small-cap stocks saying that while the small-cap Russell 2000 has outperformed the large-cap Russell 1000 by more than 2 percentage points in the year to date, the small-cap index still looks undervalued.
Malik noted that the 12-month forward price-to-earnings (P/E) ratio for the Russell 2000 stood at an 18-year low versus the Russell 1000 at the end of March, and record inflows into equity funds over the past five months have gone to almost only large-cap stocks while small-caps have seen marginal outflows.
“Over the past month, small-caps have underperformed due to the rising number of COVID-19 cases around the globe, especially in Asia, and questions over whether the economic reopening has been priced in. However, small-caps should be able to benefit from rising commodity prices and inflation,” Malik said.
And then there’s politics. The stock market was shaken on April 22, 2021, after a news report highlighted Biden’s plan to propose a near doubling of the capital gains tax rate on investors making more than $1 million a year to 39.4%. The good news is that those losses were soon erased.
Investors overall seem unfazed by Biden’s call for personal income tax hikes on the wealthy and a rise in the corporate tax rate. Stock market performance over Biden’s first 100 days in office, which ran through Thursday, was among the best of any presidency.
In part, that is because market participants expect pushback by some Senate Democrats, where the party has a razor-thin majority, to water down the proposals, analysts said. Also, the economy-boosting spending proposals are also expected to provide a lift to the economy and earnings, particularly for companies that stand to benefit from infrastructure spending and other programs.
But tax hikes and the prospect of increased regulatory scrutiny will add to a more selective environment more favourable to stock- and sector-picking, analysts said.
Those factors and the fading of other “systemic tailwinds,” such as falling interest rates will contribute to a transition away from a backdrop that saw “everything being favourable from a Wall Street perspective” to an environment with more differentiation, said Brad McMillan, chief investment officer at Commonwealth Financial Network, in an interview.
Meanwhile, the market could be due for a pullback, analysts said.
Given the scope of gains, it wouldn’t be a shock to see investors get spooked by any near-term, negative surprises on the tax front or talk around when the Fed will begin to taper its bond purchases, Krosby said, but added that at this point “all pullbacks are healthy.”