The S&P 500 took a step back this week to close roughly 1% below last week's all-time high. Participants are working through earnings reports and weighing their concerns about inflation against the threat to growth posed by the delta variant. The market trend remains well intact, but there is a more defensive leadership posture starting to develop. Quiet for much of the year, the utility and consumer staple sectors have begun to assert themselves against a deteriorating picture in the energy, financial, and material sectors. It is likely no coincidence that this change comes as the delta variant picks up steam in the U.S. and abroad. Case counts are once again on the rise, and greater restrictions have been reintroduced in some places. Still, we are not convinced that the U.S. recovery is in jeopardy. A significant portion of the population has been vaccinated or has natural immunity through exposure, and we have yet to see a substantial rise in deaths and hospitalizations from delta. If this remains the case, we expect the reopening to continue.
The same cannot be said for many countries around the world. Vaccination rates are far lower for much of the globe when compared to the U.S. Delta poses a real threat to efforts to kick start growth. Thus, we may be a way away from synchronized global growth. For the U.S., where inflation has most definitely been running hot, this could ultimately be a good thing. The June inflation report indicated that the price level rose 5.4% year-over-year. Even though a substantial portion of the gain was attributed to a meteoric rise in the price of used cars, many of the components in the Consumer Price Index continue to show year-over-year gains well above a level we are used to. The Fed remains in the camp that these increases are transitory and that the rise will slow as the economy works through bottlenecks that have built up over the past year. Softness overseas could alleviate some of the pressure in the system and allow a slower retreat from ultra-accommodative monetary policy. Right now, this view seems to be keeping interest rates low and stocks relatively attractive in general.
U.S. companies also continue to look strong in their own right. The Q2 earnings season is underway, with financials the largest contingent of companies having reported. So far, earnings have surprised to the upside by over 23%. Banks are showcasing the strength of consumers by releasing the reserves they have built up to absorb bad debt. Consumer balance sheets are simply far stronger than expected a year ago. This could be a sign of things to come for consumer-driven stocks set to report over the next few weeks. We believe the market has known this was the case for some time, and so it is not surprising that many of the bank stocks sold off following their reports. We might expect other stocks to follow suit through this earnings season. Investors often buy the rumor and sell the news.
Still, when we look deeper into the earnings presentations, we are encouraged by what we are seeing. Many CEOs are optimistic about the pace of the U.S. recovery and the economic environment they expect over the coming year. Despite concerns about labor and rising costs, there is a focus on embracing technology and driving efficiency to meet challenges. We see evidence that great businesses are becoming even better versions of themselves on the other side of the pandemic. So, while the short-term picture might be cloudy, we are optimistic about the growth prospects at many of these companies and the potential return for investors. With this backdrop, we are inclined to view pullbacks as buying opportunities.
Preston May, CBE®
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