A shift in the “dot plot” of Federal Reserve (Fed) interest rate expectations from one to two policy rate hikes in 2023 was enough to send the S&P 500® below its 50-day moving average for the first time in three months. Despite Fed Chair Jerome Powell’s comment that the dot plot with a “grain of salt,” we believe the Federal Open Market Committee (FOMC) is clearly observing inflation trends with caution and is using forward guidance proactively. To be clear, an abrupt change in the Fed’s outlook may tighten financial conditions and security valuations, but that is distinct from a shift in the business cycle which continues to accelerate.
The economic expansion continued last week with a better-than-expected industrial production report, led by higher factory output despite significant supply chain bottlenecks. Retail sales missed estimates; however, the previous two months were revised higher. leading to the highest rolling 3- and 12-month growth rates on record at 37% and 13%, respectively.
After showing signs of technical exhaustion for a number of weeks, the S&P 1500 ® hit a new all-time high on June 14 and subsequently had its worst week since February. Equities most exposed to rising inflation expectations, especially in small- and mid-cap (SMID) value, led the move lower.
SMID value stocks may have lower valuation metrics compared to their growth counterparts on an absolute basis; however, relative to their own history, both small- and mid-cap are near their 10-year averages. This suggests a limited margin of safety in value-oriented stocks during what we expect to be a short-lived accelerating expansion phase of the cycle.
With the U.S. dollar acting as a meaningful headwind for the week, the MSCI World ex USA Index was down across most countries and sectors. The heaviest losses came from the Energy and Materials sectors, and the United Kingdom was the largest country driving prices lower as officials voted to delay COVID-19 restrictions by another month.
After four consecutive weeks of positive returns, the MSCI Emerging Market (EM) Index declined, but managed to outperform both domestic and developed international counterpart indices on a relative basis. We believe the index composition of EM, which is vastly different from prior cycles, is relatively supportive as the Fed tightens policy.
Conferences for the week include the Jefferies Virtual Consumer Conference, the 2021 Macquarie Technology Summit and Wells Fargo’s “Bricks to Clicks” Digital Conference.
Fixed Income Markets
In our view, credit spreads were one of the signs that last week was not a “risk-off” reaction to a surprise change in Fed forward guidance was credit spreads. Both the Bloomberg Barclays investment grade and high yield indices saw credit spreads narrow. Even the lowest rated CCC index saw spreads narrow and remains near the lowest level in 10 years.
Chart of the Week
After falling through significant support levels in recent weeks, the bond market showed signs that inflation concerns will be transitory. The yield curve flattened to levels last seen in February, and long-dated 30-year Treasuries fell to the lowest interest rate since February 12 — the exact day when inflation expectations began moving meaningfully higher across global markets.