In the past five days, a number of macroeconomic headlines have influenced the markets amid a lull in earnings seasons. The impact on asset classes was clear, and a reversal of trends that we have seen up until now in 2014:
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While the market generally was slightly up for the week (SPY), large-caps outperformed (DIA) as did small-caps (IWM), although volatile technology stocks underperformed (QQQ) as valuations remain high in that sector. But the biggest winner was gold (GLD), while the biggest loser was bonds (TLT), which have had a surprising bull run that makes them still the best-performer for the year-to-date period.
The change in performance this week may signal a changing perception: investors are no longer concerned about deflation, a contracting economy, or lower aggregate demand. Quite the opposite: demand for gold, the inflation-hedge, is surpassing demand for everything else.
In Europe, inflation is a much bigger concern of Central Banks despite failing evidence of real inflationary pressure. This tension between fears and reality played out most clearly in England. Earlier in the week, we heard that the Bank of England would consider an interest rate increase, but at the same time we heard that data showed lower-than-expected inflation that was also below the bank’s target.
Stateside, inflation remained subdued but accelerating, with the CPI showing an uptick in May to 0.4% change in prices, which may suggest aggregate demand is getting strong enough for vendors to raise prices more than in the past.
Other indicators, particularly unemployment, bolster this narrative. The headline drop in jobless claims is encouraging greater confidence, which in turn is leading to more conviction that America’s economy is staying on the right track.
In housing, a growth in housing permits that was below estimates but nearly 10% higher of last year’s rate indicates that the economy is doing better and should, in turn encourage greater returns for U.S. based companies with a consumer base of Americans.
This is all good stuff, but if you’re an investor, how do you play this trend? The vanilla answer is to invest in U.S. stocks, which is why we see green across market-caps, but the S&P 500 P/E ratio is getting high, with the psychologically important number of 20 looming soon. Earnings growth in the next quarter is essential for more money to pour into SPY.
Meanwhile, large-caps and small-caps remain relatively under-performers for 2014, which explains why they have done well for the week. While SPY is up 6% YTD, both DIA and IWM are up only around 2% for the same period, meaning that a more concentrated allocation may beat a more general bet.
In summary, the new trend of this week is one of confidence in an expanding economy, and the expectation that expansion will also cause inflation to return. Such a view is optimistic, and may be tempered by next quarter’s earnings season and upcoming announcements of U.S. GDP growth. Investors currently are not expecting much volatility, but that may change if further macro data surprises and disappoints.