After spending the first half of calendar 2021 digesting and positioning around rapidly improving economic fundamentals, longer term investors essentially took a breather and allowed the shorter-term and higher-octane traders to rule the July roost. It wasn’t such a bad result – a fully diversified equity portfolio ended up a bit under 1%. But there were such significant performance divergences among asset classes and sub-asset classes that it would be difficult to draw any true conclusions from the month.

Strong corporate profits this quarter

What is not in dispute was the strength of corporate profits during Q2. With roughly 50% of the S&P 500 now having reported, the vast preponderance of the data (like 91%) shows revenue and profit ‘beats’ versus Wall Street analyst expectations…and for those companies which provide forward-looking guidance, an almost equivalent percentage have ‘raised’ Q3 and even full year 2021 estimates. Fully aggregated S&P 500 earnings for all of 2021 are now approaching $200/share, significantly above those recorded in 2019.

Economic recovery in full swing!

Also not in doubt was the strength of the economic recovery. The first look (the ‘flash’ report) at Q2 GDP growth came in at 6.5%, which though in fact was well below 8+% expectations actually proved even more latently powerful in the truly key sub-components than even the most bullish of economic forecasters had been looking for. Most notably, consumer spending increased by 11.8% and business investment soared 8.0%. The level of aggregate corporate profits (for the entire economy, not just for those traded publicly) could well have risen to nearly $2.9 trillion, massively above the $2.4 trillion at the pre-Covid height. This bodes extremely well for future employment, wages and capital spending. Not surprisingly, consumer sentiment numbers are ahead of forecasts.

On a ‘furthermore’ note, much of the miss in the 6.5% flash versus the 8+% expected came from a drawdown in inventories, i.e., fewer goods were produced versus those sold. Although quite correctly reported in the immediate moment, this is actually a contrary indicator for the future. Transitory bottlenecks in supply chains will over time be alleviated and eventually fully reversed and the aggregate ‘re-stocking’ will add even more to economic growth later on.

But these two were really never in doubt to begin with. If you had already expected a ‘beat and raise’ either at the macro aggregate economy level or at the micro stock-by-stock, the final actualization doesn’t provide any further impetus to asset prices. The markets are absolutely outstanding at discounting the future it already expects. What is required to move prices are changes in such expectations, in terms of both duration and magnitude, and that most certainly did not occur in July.

The traders took over, trying to identify and then perhaps exacerbate any potential short-term momentum wherever it could be found. Among the major macro market benchmarks, the most significant change in price occurred in the U.S. Treasury market as the yield on the U.S. Treasury 10-year bond fell from 1.44% to 1.25%. I had noted an earlier decline (from a 1.75% peak on May 10) a couple months back as Wall Street’s true rejection of the inflation ‘scare’ that had briefly created some angst among major pundits, especially those with a bearish agenda to begin with. Though I could be wrong, I believe this further, and indeed significant, extension of the fall in yields can be largely attributed to traders utilizing leveraged strategies to keep pushing on a market that had already proven susceptible to price (or in this case yield) pressures.

International Emerging Markets lagging

A second major divergence came from the International Emerging Markets, which lagged the S&P 500 by nearly a full 6% in July. Much of this of course came from the large declines in major Chinese technology companies (Alibaba, Pinduoduo and Baidu among many others) traded principally in the United States, facing seemingly strident regulatory restrictions from the Chinese government which perhaps has come to regard these as usurping too much economic power. To be sure, these represent a small, perhaps even fractional, amount of global economic activity and market capitalization. But their relatively high profile made them, and no doubt will continue to make them, a very easy and tradeable target, in both directions.

Despite this, the relative value of the U.S. dollar dropped a bit in July, by about a half-percent...and accordingly, gold and the entire commodity complex did just fine.

FAAMG leads the markets

The FAAMG (Facebook, Apple, Amazon, Microsoft, and Google/Alphabet, and the like) cohort reasserted itself as market leadership in July. These are always trader ‘faves’ since these stocks turnover in massive share and dollar quantities every day. The three best equity sectors in July were electric utilities, health care and real estate, all finding relative trader support as the banks, energy and industrials faded a bit.

Last month I introduced (or, for my very long-time readers, re-introduced) the term ‘rain delay’ – my expectation that the structural bullish direction of the financial markets will go into temporary hiatus, perhaps lasting through the end of the calendar summer. Though slightly positive, I believe July will prove to have been its earliest onset. I also noted several factors that could create the rain delay ‘backstory’ and one in particular has become very front and center.

Impact of the Delta variant

It seems quite possible that the delta variant is going to create at least some temporary slowdown in the economic re-opening acceleration. Perhaps the silver lining will be that its very serious renewed health impact will force the many non-vaccinateds, even if kicking and screaming, to go get the shots, allowing finally for herd immunity to take effect.

Infrastructure package

Secondly, though the Senate has indeed advanced the ball downfield vis-à-vis a bipartisan infrastructure package – in my opinion the single most important factor in allowing for a re-boot of the highly indulgent and transactional economy that marked the end of the last decade – the legislative sausage in still months ahead in the making. There are a lot of legislative distractions along the way, specifically the budget and debt ceiling debates. Though I have ultimate confidence in an inexorably successful outcome, that ‘inexorability’ will remain in doubt until it finally occurs, just as did the debt ceiling and fiscal cliff resolutions in 2011 and 2012, respectively, and even the tax cuts in 2017.

August (and September) is seasonally one of the, shall we say, less inspired months of the year, especially after huge positive performance in the first half. Our longer-term bullishness remains, as does our overweight to stocks in client portfolios. In fact, we would welcome a chance to do even more, which is indeed the kind of opportunity rain delay is apt to create.