Summer Yields and SPX
May 24, 2021
Summer yields: Last week’s pickup in Eurozone flash PMI data has the region looking like a complimentary growth engine to the US expansion. The Eurozone doesn’t have the same kind of fiscal stimulus but has a much larger bounce coming from its reopening. US May flash PMI data was also stronger than expected with the manufacturing survey showing another extension in delivery times as the pandemic and subsequent reopening have upended the normal elasticity of supply to meet demand swings. The record extension of delivery times suggest pricing pressures should continue, especially in areas where demand is greatest. Net/net, these bottleneck pressure and pricing pressures aren’t going to end anytime soon with US core inflation probably reaching +2.8% this year (would be the highest since 1995). In the near-term, the Fed should be able to continue its argument around pricing pressures being transitory and unlikely to budge on key themes for ‘low for long’ and the need to fully achieve goals on inflation/employment. This makes improved labor market data the key to higher bond yields and curve steepening. Expect bond yields to stay in the ~1.60-1.635% range in the near-term with the next major catalyst being Nonfarm payrolls in the May Jobs Report on Friday, June 4. Headwinds to labor market normalization including childcare and residual Covid fears are likely to remain, but last Friday’s US PMI data also showed considerable strength in labor market components. It may not happen on June 4, but ultimately expect 10-year yields to break above ~1.69% with a pause at ~1.79% before releasing to 1.90-1.98% later this summer.
Summer SPX: Consensus S&P 500 EPS estimates started drifting higher last week with 2021 going from $185 to $188 and 2022 going from $205 to $211. At current levels, the consensus 2022 estimate sill implies a punchy forward multiple of 19.9x, but the trajectory on estimates is still aimed higher. Over the next two weeks, it’s conceivable for the 2022 estimate to push toward $225 for a 18.7x implied forward multiple. Don’t look for multiple expansion during the summer as higher bond yields will likely hold back growth multiples and an uncertain policy backdrop will keep discounts in place. Uncertainty around the growth-policy tradeoff followed the unveiling of Biden’s spending plans and the higher-than-expected April US CPI print. We could easily see another spike higher in May core CPI due on June 10 before the June inflation data in July shows signs of peaking. The Fed meeting on June 16 will likely reassure investors that monetary policy is unlikely to change anytime soon with the committee reiterating the view of a transitory inflation move only. The combination would lead to higher yields and curve steepening with value equity sectors (Financials in particular) as primary beneficiaries.