Should We Take Cues from the Bond Market or the Equity Market?

July 2021 was quite interesting for the market, as it featured a micro-correction followed by a swift rebound in the second half of the month. First, restrictions in the U.S. were largely lifted, then came the excitement of doing what used to be normal, such as going to a restaurant or seeing a movie. In hindsight, perhaps we moved a bit too quickly to revert to our 2019 lives. As mobility increased, so too did the spread of the delta variant, especially among unvaccinated populations. Concern about delta and the subsequent tripling of COVID cases in the U.S. caused a brief risk-off trade.¹ And with concerns of a third wave in the U.S. running high, the yield on the 10 year-Treasury fell from its peak in March from 1.75% to 1.18% in mid-July.

Perhaps the bond market saw what’s happening across the pond and thought the U.S was next. The Delta variant has the U.K. experiencing its third wave of COVID infections, though there are signs that cases have peaked. Domestically, rising Delta case counts could pose challenges to the reopening, at least regionally. The bond market is known for being more contemplative and forward-looking than its brasher sibling, the equity market. If the bond market is correct, the U.S. economy may face slower growth and inflation that isn’t so transitory. But as yields start to move higher again, including the 10-year Treasury now at 1.3% (as of 7/23/2021), we are in the camp that the bond market may have drawn a faulty conclusion.

On the positive side, we see some easing in the supply chain constraints that caused prices to jump to their highest levels since before the 2008 financial crisis.² Freight costs remain stubbornly high, which affects smaller companies, the lifeblood of the economy, more than larger multinationals. However, we expect the Federal Reserve (Fed) to maintain its dovish stance for the foreseeable future.

Significantly, the consumer is healthy and strong. Now, consumer spending is starting to shift from goods to services as life returns to something more normal.³ We believe that as services spending rises, goods consumption could slow but remain at an elevated level. It was estimated that a 10% increase in time spent at home during the pandemic was a 3.1 percentage point headwind to consumer spending.⁴ This pivot should help ease supply disruptions and mitigate some inflationary pressures over the next few months.

Of course, tail risks now include the highly transmissible delta variant. Beyond mask advisements, we do not expect mandatory measures placed on the U.S. population, but even voluntary social distancing poses moderate downside to the economic outlook.

Sector Views

In the second half, we expect the market to focus more on valuations across sectors and become more selective. In that sense, perhaps the often-brash equity market is growing up.
Supply chains constraints are a particularly important consideration in the reopening economy, but numerous factors shape our current sector views.