Cautiously Bullish Outlook Despite Fed Hawkish Surprise

The stock market posted another positive month in June with the tech-heavy Nasdaq outperforming the market by gaining 5.5% while little changed with the cyclical-heavy Dow. The S&P 500 advanced 2.3% in June with YTD return of 15.0%. The technology sector came in as the top performer, followed by energy, communication services and real estate while financial and material sectors lagged. Overall, a decrease in the long-term bond yields (the benchmark 10-year yield dropping below 1.5%) favored growth stocks by reducing the implied discount rate on future earnings. Lower yields coupled with a flattening of yield curve weighed on financials by threatening bank lending margins as banks tend to profit from larger spreads between short-and long-term rates. The energy sector benefited as crude oil increased by more than 20% in the second quarter driven by supply discipline, growing demand and upward travel trends.

A surprisingly hawkish outcome from the Fed Reserve’s June policy meeting unleashed massive immediate repositioning in the financial market, but did not change our cautiously bullish market outlook.  Thirteen of eighteen Fed officials see the first rate hike occurring by the end of 2023. The dot plot now shows two rate hikes in 2023, but it’s not clear how aggressive this tightening cycle will be, as it depends on how much of an inflation overshoot the Fed will allow.  Given the recent mixed labor market data and the unemployment rate still as high as 5.8%, we don’t expect the Fed to announce its tapering until September and think the actual tapering might not start until 2022. We believe one of the following scenarios is likely to occur:  

• Our baseline scenario of gradual policy normalization together with transitory inflation and solid economic recovery leading to moderate yet positive equity return.
• In a riskier scenario of persistent inflation coming together with strong growth, equities should still do relatively well, although with the possibility of higher volatility.
• A third scenario of stagflation, characterized by slow growth/high unemployment and high inflation, would be harmful for the market. However, we believe that the probability of this worst case scenario is low. 

The recent data confirms that the economic recovery is still in good shape. The ISM manufacturing index continued to increase, and the consumer confidence index rocketed more than expected to the highest level since February 2020 as consumers' concerns over inflation eased and spending plans picked up. Labor market data was mixed with payroll gains falling somewhat below expectations and weekly jobless claims remaining well above the pre-pandemic average. The lackluster employment data, however, helped to calm market fears about an overheating economy and potentially persistent inflation.

Moving forward, we believe the firming economic backdrop, more synchronized global recovery, strong consumer spending outlook and another batch of strong corporate earnings should support further equity upside. Volatility is also expected down the road with the key sources of uncertainty including inflation fear, tax policy concerns and the market’s sensitivity to the Fed policy.  

By the Numbers (Year-to-Date)*

U.S. Equities (S&P 500 Index) | 15.0%

International Equities (MSCI ACWI ex-U.S.) | 9.2%

U.S. Bonds (Barclays U.S. Aggregate Bond Index) | -1.6%

Global Bonds (JP Morgan Global Aggregate Bond Index) | -3.2%

The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. equity outlook.  This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.

As of 6/30/2021. Data provided by Bloomberg, NorthCoast Asset Management.

*Source: Bloomberg, WSJ, NorthCoast Asset Management.

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