There were two notable changes to the June Market Multiple Table and each change alters the common perception that 1) A dovish Fed is the best Fed for stocks (that’s not entirely true at this point) and 2) That the labor market is a long way from recovery (that’s not entirely true at this point, either).
Scroll down below to download a printable version of this month's Market Multiples Table.
Here are some quick definitions to help you follow along.
Hawkish - is when the Fed is guarding against excessive inflation. The Fed is either raising rates, or they're considering it raising rates to keep inflation in check.
Dovish - on the other hand, is basically the opposite of hawkish. This is when the Fed is less worried about inflation and more worried about weak growth, high unemployment, or even deflation--the opposite of inflation because the economy is either growing weakly or even contracting. The Fed tends to lower interest rates to stimulate the economy that isn't growing.
Goldilocks Economy - a Goldilocks economy is not too hot or too cold but just right - to steal a line from the children's story "Goldilocks and the Three Bears." The term describes an ideal state for an economic system. In this perfect state, there is full employment, economic stability, and stable growth. The economy is not expanding or contracting by a large margin.
Starting with the Fed, the surge in inflation statistics has caused a mild shift in the market perception of Fed dovishness. Simply put, the market does not want the economy to run “Too Hot” and for inflation to gain serious momentum, so it wants the Fed to acknowledge that’s a risk. That’s started to happen via the FOMC minutes from the March meeting and numerous Fed members acknowledging that the Fed is “talking about, talking about” tapering. Looking for-ward to June, the market will want to see the Fed formally admit it’s “talking about, talking about” tapering, without admitting that it’s imminent.
Second, the very soft April jobs report has caused some concerns about the structure of the labor market. Normally, disappointing job reports are caused by a lack of available jobs (i.e. no hiring). But the April report was most likely caused by a lack of workers wanting to work. If that continues, it will cause wage inflation as employers increase wages for a smaller workforce. The fear, though, is that the soft jobs numbers cause the Fed to stay very dovish, which could then stoke inflation fears, which would send the 10-year yield higher.
Those are two unconventional yet important subtle changes that will impact markets through-out June, especially given the looming jobs report and the FOMC meeting later this month.
Current Situation. It’s fair to say the Current Situation deteriorated marginally since May, and that’s been reflected in the fact that the S&P 500 has been “stuck” for the last month at 4200. The market is now looking for a Goldilocks Fed response of not too dovish and not too hawkish, while the labor market is weaker than expected—but because of labor supply and not a lack of available jobs. However, offsetting those two slight negatives are that inflation expectations have not continued to rise, and the 10-year Treasury yield remains subdued. Mainly because of that stable yield, the net result is that the multiple and expected earnings didn’t change, and neither did the target range.
Things Get Better If: The Fed is Goldilocks, the Labor Market Recovers, Inflation is Anchored, Yields Stay Low and 2022 EPS Expectations Rise. This is essentially the “best case” scenario for stocks in that the Fed stays Goldilocks, the labor market improves because supply increases (which will relieve wage pressure), inflation expectations don’t surge, and the 10-year yield stays stable. This near-perfect scenario would lift S&P 500 earnings expectations for 2022 to as high as $225, which gives the S&P 500 notable upside from here.
Things Get Worse If: Inflation or Yields Rise and the Fed Gets too Dovish or Too Hawkish. The list of things that can “go wrong” grew from May to June, and it now includes 1) The Fed getting too dovish (and inviting inflation) or too hawkish, 2) Inflation rising sharply and/or 3) The 10-year Treasury yield moving sharply higher. If one of those things happen, we’re likely looking at a 5%-10% correction. However, if multiple events happen, we’re looking at a 10%-15% correction.
Bottom line, the Market Multiples Table this month reflects the simple truth that June is a very important month for markets, because if the Fed makes a communication error at the meeting, then it can negatively impact two other macro influences (inflation expectations and the 10-year yield) and that means a pullback (if not correction). Point being, it may be summer, but this may be the most important month for markets yet in 2021.
If you have any questions on this, feel free to use me as a sounding board for you by reaching out to me (contact info below) or by scheduling a virtual meeting with me (click here to schedule a virtual meeting with Kurt S. Altrichter).
If you have any questions on this, feel free to use me as a sounding board for you by reaching out to me (contact info below) or by scheduling a virtual meeting with me (click here to schedule a virtual meeting with Kurt S. Altrichter).
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com