June was abnormally quiet for equities across the globe despite a few sharp rallies and declines. Most markets were narrowly changed in the month, but the lackluster results did not alter the 2nd quarter and YTD upward bias in stocks.
International and Emerging Markets by quarter’s end appeared to abandon the some of their strength relative to domestic markets that had been displayed early in the period.
In the US, uncertainty about the fate and details of legislation pending before Congress and mixed, occasionally contradictory messages from Democrat leaders, kept investors guessing. But given the chance and a bit of positive news, prices consistently defaulted to the upside.
New highs were posted by many indexes but slack volumes and lackluster investor enthusiasm more characteristic of the “dog days” of August were the rule for many trading sessions. Performance of key global equity benchmarks is below.
Inflation fears have, for several months, been one of the financial press’ favorite topics. Strong upticks in both the Producer Price and Consumer Price indexes for April and May fueled widespread predictions that the Federal Reserve will be forced to speed up its tightening schedule to counter the trend.
It is entirely possible that this year’s accelerated inflation is due to pressures on constricted supply lines and recovery by consumer and manufacturing demand. The Fed has consistently characterized recent inflation in the two indexes above as “transitory.”1 We are inclined to agree, and performance in the bond market suggests the same conclusion.
US Treasury yields were higher June 30 compared to the end of last year, but since March 31, have actually declined, as the chart below illustrates. To date, credit market investors appear little concerned that the US is on the brink of another 1970s style inflationary spike.
The strong uptrend in commodity futures since the US economy’s trough last April has been a pervasive contributor to perceptions that inflation is threatening to surge beyond the Fed’s control. This position is certainly understandable if one focuses solely on prices.
Anyone in a supermarket consistently this year knows that the cost of meats has risen roughly 50% over the past several months. Is this another “new normal” or are consumers likely to see prices retreat as supplies are replenished?
The law of supply and demand was not repealed by the pandemic and many futures have declined significantly from their mid‐quarter peaks. A certain percentage of demand is elastic, which means that demand will taper when prices rise to levels consumers are unwilling or unable to pay. Lumber is a prime example.
Many will have heard anecdotes of new home constructors confronted by sharp, post‐contract price escalations due to soaring lumber costs. Some accept the hikes, but others defer.
When purchases are not time sensitive or when alternatives exist, supply shortages can suddenly recede as demand wanes.
The chart of lumber futures closing prices from December 31, 2019, through July 6, 2021, (below) is instructive. After more than quadrupling from March 2020 to May 2021, prices have been halved since.
Charts for grains and meats are similar to that of lumber, with peaks, after steady multi‐month advances, posted in mid‐May.
Commodity prices, by definition are a balance between available supply and corresponding demand. When prices rise to levels at which demand begins to decline, prices will inevitably follow. The below chart shows the Dow Jones Commodity Index (DJCI) from December 31, 2020, to July 6, 2021.
The last new high for this index was on June 4. We can’t know if the final high has been reached in this cycle, but the above chart may be the precursor to a more prolonged decline, reflecting consumer resistance to lofty end prices and more efficient supply chains.
But there are always exceptions. Oil has a significant degree of inelastic demand. Energy is essential to consumers and businesses and little resistance (other than vocal) to higher prices will be generated by higher costs. Oil and gasoline have been climbing steadily since the second half of last year and while US production has been relatively stable at levels about 20% below the early 2020 peak, the prospect of reattaining or surpassing previous years’ domestic output has diminished.
The Biden Administration has signaled with rhetoric and actions that US energy independence is no longer a policy priority. Instead, alternative energy sources will be emphasized and subsidized in a push to eliminate fossil fuels.2
We suggested in our 2021 outlook that inhibiting the ability to exploit our vast petroleum and natural gas reserves would create unwelcome leverage for OPEC. Comments recently from the President suggest this is becoming a reality.
Mr. Biden has asked OPEC for increased production to counter the steep rise in US gasoline prices.3 At the same time, however, the administration is canceling pipeline construction and instituting measures that limit domestic oil output and exploration. The solution to this conundrum seems obvious and the President’s exhortation to OPEC, curious.
Although a recent Federal court injunction prohibited the government from unilaterally cancelling existing contracts and leases to drill offshore and on federal lands,4 markets appear convinced the government is willingly subjecting citizens to the whims of OPEC ministers. The result has been a roughly 50% increase in WTI prices since the end of 2020 (below). We suspect strength in oil (and gasoline) has somewhat masked the magnitude of declines by many components of the DJCI since late May.
Second quarter earnings reports will be flowing soon, and we can expect very favorable comparisons to last year’s period, much of which encompassed the worst of the economic shutdown. Earnings have been “catching up” to equity valuations, which could also be a factor adding to market sluggishness.
If the second half of 2021 is unencumbered by increased government “economic guidance,” the stage could be set for further meaningful equity gains this year.
The bond market continues to reserve judgement on the President’s ambitious spending proposals and with the August Congressional recess less than a month away, we expect no imminent resolution to current impasses.
The possibility that Democrats will ram through their proposals without Republican participation is very real, despite recent polls indicating the public’s lack of support for many of the President’s policy goals.5 Should Senate Democrats employ reconciliation to pass House generated spending bills, we expect them to be punished by voters in 2022.
Investors with a solid long term plan, holding globally diversified portfolios, will continue to benefit from firm equity and bond market performance. The future holds significant uncertainty on the political and economic fronts, but we can be assured that once laws are passed and future incentives evaluated, markets will rapidly render their opinions.
1 “Minutes of the Federal Open Market Committee, April 27‐28, 2021,” www.federalreserve.gov, May 19, 2021. 2 “FACT SHEET: Biden Administration Advances Electric Vehicle Charging Infrastructure,” www.whitehouse.gov, April 22, 2021.3 “Biden administration pushes for 'compromise solution' in OPEC+ talks,” www.reuters.com, July 5, 2021. 4 “Federal Judge Stops Biden Administration From Blocking New Oil and Gas Leases,” www.wsj.com June 22, 2021. 5 “Poll: Biden agenda may hurt Democrats in 2022,” www.thecentersquare.com, May 26, 2021.
This commentary is provided for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Content has been obtained from third-party sources and is believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. The commentary may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.