Signals or Noise?

The annual gathering of central bankers at Jackson Hole is always watched closely by policymakers, economists, and investors. As summer draws to a close, the watch on this week’s event — taking place August 26-28 — is even more intense than usual. A year ago, it was clear even before Federal Reserve Chair Jerome Powell laid out a new, more expansive approach to monetary policy that the Fed and other major central banks would maintain an easy stance unchanged for months or even years. Now, everyone sees a policy shift on the near horizon. Hopes are high that Fed Chair Jerome Powell will signal what is to come and when in his Friday speech to the symposium.

Those hopes may be disappointed. The surge in Covid-19 since the last FOMC meeting has forced a last-minute shift to hold the event online again. Dallas Fed President, Robert Kaplan, indicated late last week that he may moderate his typically more hawkish views on taper timing in light of the rising cases of the Delta variant. And mixed signals on growth have only muddied the outlook in recent weeks. Powell, who has been treading carefully as the end of his term approaches, is likely to aim his remarks at keeping markets stable and guessing. Why spell out sooner than is necessary when markets should expect the upsetting news of a new tightening cycle?
Observations and takeaways for investors:
What a difference a year makes

Looking back at the 2020 reports on the Fed’s then-newly announced policy framework is a reminder of how dramatically the economic debate has shifted. A year ago, there was widespread skepticism that the Fed would be able to bring inflation up to the 2 percent target, let alone that inflation would ”moderately exceed” the target for a period of catch up, as Powell said was the goal. Since then, inflation has far exceeded expectations, although views still differ on whether the rise will prove “transitory” as the Fed says it expects or will become embedded. Unemployment has come down more than expected, although FMC members agreed in their July meeting that there has not yet been the “substantial progress” towards its full employment goal that it would like to see before policy is tightened.

The stronger recovery was powered in large part by fiscal stimulus not in the cards a year ago. It led Powell and its colleagues to bring forward their expectations of when tapering and interest rate “lift-off” would be appropriate. In June the Fed moved to raise its growth and jobs forecasts closer to the consensus. And minutes released last week showed that the FOMC was discussing tapering — in general terms — at their last meeting in July. Since then, however, economic signals have only added to uncertainty. Unemployment claims continued to decline in the first half of August, although at 300k plus they remain well above pre-pandemic levels. Job openings are at an all-time high since the BLS initiated the JOLTS measure in 2000. Inflation is also high. But retail sales dropped more than expected in July and some real-time data showed a deceleration of demand, and even a slight drop in air travel. Indeed, for the Fed’s June growth forecast of 7 percent for this year to be met, the data need to surprise on the upside in coming weeks. That looks unlikely as long as Covid-19 continues to cast a shadow over the world.

To open or not to open: views differ

This summer has brought bad news on Covid-19. Infections are up. Vaccines need boosting after six to eight months. Hospitals and intensive care units are getting dangerously full in many US states as too many Americans remain unvaccinated. Even the vaccinated can spread the virus, although they are much safer from severe disease themselves.

The impact of this bad news on the US and global economy is uncertain. But one thing is clear: employers are divided on how to react. A number have decided this month to postpone a planned return to the office. Instead of Labor Day marking an end of summer “back to work” moment, like in pre-pandemic days, it is likely to be a reminder that Covid-19 is here to stay, in some form or another. This makes CEOs, especially of New York financial institutions, unhappy.

At RockCreek, we had hybrid and remote work prior to Covid-19 and have thought for some time that such models were here to stay. The pandemic, and its unexpected twists and turns, triggered the shift in work arrangements. But even if we get used to living with Covid-19, the experience of the past 18 months has made many people take a new look at what they want and can get out of work. More flexibility is just one part of that for many. It is perhaps surprising that some large institutional employers — including the World Bank and the other IFIs in Washington — have chosen to push off the return to work until 2022. Why not experiment with what hybrid model works best to promote productive work? At the same time, RockCreek has had team members coming into the office and traveling for work, and we will be starting to experiment with a few days in the office — hoping for a full return in October or later.

US equity markets avoided their worst weekly performance since mid-June with a market rally on Friday in the wake of commentary from Dallas Fed President Robert Kaplan. The S&P 500 closed 0.8 percent higher, with 416 names advancing. This broad rally is a departure from recent trends as the breadth of the US equity rally had been narrowing despite the S&P 500 hitting (another) all-time high last Monday. Despite setting records, the percentage of S&P 500 stocks trading above their 200-day moving average has fallen from its post-covid peak of ~97 percent in late April to ~75 percent. This is the lowest proportion of names trading above their longer-term moving average since before the vaccine announcement in November 2020. We have also seen a reversal of Q1 sector moves. Consumer discretionary companies including travel, entertainment, gaming and cruise lines have been lagging since April after a strong start to the year. Energy has turned recently into the worst performing sector as growth concerns, particularly related to travel, have weighed on the demand outlook since the arrival of the delta variant.

Given the uncertainty in investor sentiment, it is not surprising that Kaplan’s words had an impact on the market. Some assurance that the Fed will be reactive to worsening conditions, not just an improving economic scenario, reassured investors that monetary policy will continue to support risk assets in the event of a material slowdown in growth — i.e. the market seems to have fixated so much on the inevitability of tapering given recent inflation data and a rebounding economy that investors may be concerned the Fed will not take into account a decelerating recovery and push out the tapering timeline as needed. Kaplan’s message may go a long way in allaying those fears as he has been one of the more hawkish Fed members in recent months. Last Friday’s market moves with growth and technology stocks outperforming is a trend we would expect to see should a more permanent deceleration materialize, and monetary policy support continues unabated.

The US equity market was not the only one to take notice. European equities also benefited from Kaplan’s remarks, reversing losses in the Stoxx 600. Europe ended the day 0.5 percent higher, capping that index’s weekly loss at -2.3 percent. Similar to the US, Technology was the best performing sector in Europe on Friday, led by Semiconductor and Semiconductor Equipment companies.

On the other hand, Japanese equities closed lower on Friday, sinking 4 percent for the week. This is the Topix’s worst weekly performance since the last week of February. Automobiles & Components weighed heavily on performance as Toyota announced it planned to reduce production by 40 percent in September, citing not only semiconductor shortages, but shortages in other supplies as well.

Not a tantrum, but…

Some things don’t change. Whether it is concerns that the US is tightening policy or loosening, growing stronger in the world or weaker, signs of change and uncertainty usually push worried investors to keep their money — guess where — in the US. With post-Afghanistan geopolitics looking worrisome, Covid-19 cases still rising globally, and — most importantly — the approach of US tightening at the same time as other growth sources may be weakening, emerging markets require a cool head.

In emerging markets, we witnessed a return to what has become the status quo in EM markets — with the reference MSCI benchmark once again underperforming the ex-China benchmark. Continued regulatory pressure and ensuing investor skittishness led to another round of losses in Chinese equities. The prospect of wealth redistribution efforts aimed at the Billionaire class and monopolies, as well as a rare public rebuke of real estate developer Evergrande for its efforts to secure a government-sponsored bailout, were additional signals Beijing is calling the shots. The word of the week among our local partners in China was ‘transition’. That is, it’s abundantly clear China Inc., for years reliant on consumer-centric technology companies to drive growth, is now shifting its focus on strategic technologies in the microchip, artificial intelligence, and green energy sectors. While we’ve known the e-commerce, online entertainment, ride-hailing, and search engine champions of China for some time, it is not yet clear who will emerge as the future semiconductor and EV battery champions. If history is any indication, the speed at which Beijing authorities drive transformative change indicates we could see very different equity market leaders in a matter of years, not decades. Hold on to your seats.
It was anything but a boring week outside of China due to emerging markets’ central bank policies. While the Fed and the ECB have yet to make significant moves, 2021 has seen the Brazilian and Russian central banks aggressively hike rates. Likewise, Mexico’s central bank hiked rates in June for the first time since 2018. Given where inflation forecasts stand, the recent round of tightening is likely just the beginning. Markets are expecting large interest rate increases across Latin America and EMEA. While a tailwind for these countries’ currencies, (especially given the FX corrections of last year), higher interest rates also typically coincide with lower equity returns as domestic investors re-engage fixed income assets with nominally attractive yields. This explains in large part the correction we have seen in Brazilian and South African equity markets month to date. Much of the capital outflow has been retail-driven, an indication, perhaps that institutional investors are staying the course and taking advantage of attractive valuations. In addition, foreign flows have taken up some of the slack generated by domestic selling. As we have noted previously, stock selection will play a key role in generating value in the face of these dynamics across emerging market countries.
Market Pricing of EM Interest Rate Moves over the Next Twelve Months (bps)
Domestic and Foreign Net Equity Flows: Brazil
RockCreek Update
RockCreek Founder & CEO Afsaneh Beschloss discussed opportunities in climate and impactful investments on Yahoo Finance. Watch here.

Team RockCreek

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