Stock Market Volatility Is About to Resume

Going forward, there will be a shift in consumer spending toward activities and sectors most impacted by pandemic restrictions at the expense of Covid-19 winners. The May retail-sales report shows that food-services and drinking places and clothing stores—the two sectors most severely affected by the pandemic—experienced the strongest sales in May, with both exceeding their pre-Covid sales level. Meanwhile, consumer spending on nonstore retailers, building-material and garden-equipment dealers, and hobby stores—which all experienced robust sales growth over the past year—declined in May. This reversal in spending patterns is also corroborated by the ISM surveys, which show that the improvement in services has recently been outpacing that of the manufacturing sector.

The U.S. economy is entering a (benign) slowdown phase—a risk to cyclical equities that typically underperform during this stage of the business cycle. Our U.S. equity strategists favor industries such as hotels, restaurants, entertainment, and airlines, which will benefit from pent-up consumer demand for services.

—Roukaya Ibrahim

Volatility on the Rise

BTIG Quick View
BTIG
June 16: Whether it is the two-year note yield breakout above 0.20% or the five-day realized volatility in the

S&P 500

index pivoting from an unimaginable 1.38%, “flatlining,” or the motionlessness of asset prices prevailing since the 10-year-yield peak at the end of March, appears to have ended. The Federal Reserve’s uncertain certainty on inflation being “transitory,” the labor market supply/demand imbalance clearing, and the timing of more taper talk (forget Jackson Hole in late August—the normally “sleepy” July 28 FOMC meeting is now likely to have as many fireworks as the Fourth of July) are likely to underpin volatility this summer.

What is certainly certain is that there is more inflation straight ahead, and stocks’ discomfort three to four months after an unnaturally low volatility period and with 2%-plus core PCE is well documented. We continue to see value in owning SPX July 30 straddles, and with the expectation of 10-year yields resuming their climb toward 2%—now an equity headwind—would skew equity exposure toward yield-indifferent defensives such as healthcare and away from both transports (high oil is beginning to bite) and yield-sensitive, high-multiple growth.

—Julian Emanuel, Michael Chu

Muni Market Challenges

Market Commentary
Cresset
June 16: Favorable supply-demand dynamics have helped drive high-quality municipal bonds to become the best-performing investment-grade bond market this year—munis outpaced emerging markets, corporate bonds, and Treasuries through May. It is the only investment-grade asset class that delivered a positive, albeit small, return for the year against a backdrop of higher yields. Unfortunately, munis could become a victim of their own success. Massive buying has propelled AAA municipal bonds to their lowest yield relative to Treasuries in history, offering holders little protection in the event interest rates rise or personal income-tax rates hold steady.

We recommend that investors hold investment-grade munis for cash-flow purposes only. We aren’t concerned about credit quality among our nation’s top municipalities, and we believe that holders deserve an incrementally higher yield for holding those issues. We expect quality municipals to underperform their taxable counterparts once supply comes back on-line this fall.

—Jack Ablin

Proxy-Season Postmortem

CIO Weekly Perspectives
Neuberger Berman
June 14: Many [environmental and social] issues have come up in this season’s [proxy] votes. We have been pressing a lot of companies to improve their performance and throwing our support behind those we regard as best-in-class.

We supported the boards at

Waste Connections

and

Home Depot

in recognition of their efforts to enhance pay and benefits, and create a safe environment for their frontline workers during the pandemic. In contrast, we voted against the board of Chartwell Retirement Residences and in favor of a shareholder proposal for additional disclosure on work practices, given the substantial pandemic-related risks it faces as Canada’s largest operator of senior-living residences.

On the critical governance goal of ensuring diversity of perspective and expertise on boards, we have singled out the insurer Progressive Corp. as a leader. While only 28% of S&P 500 directors are female, it has achieved board gender parity. Seventeen percent of its directors are from ethnic minorities; moreover, the chair is female, and that board diversity is reflected in senior-management appointments. At First Solar, however, we voted against a board with no minority representation in favor of a shareholder proposal for additional disclosure on how it seeks diverse candidates; and at Union Pacific, we supported a shareholder proposal for disclosure of EEO-1 reporting, which passed with 86% support.

In our efforts to keep compensation and incentives appropriately aligned with shareholder interests, we opposed boards on senior-management pay at a number of companies, including

General Electric,

Heineken,

Amerisource Bergen, and Russia’s

X5 Retail Group.

We voted in favor of shareholder proposals for reporting of political contributions at

Netflix

and lobbying activities at

Charter Communications.

And in pursuit of transparency into environmental risks, we supported shareholder proposals for enhanced emissions disclosure at

Berkshire Hathaway,

Phillips 66,

and

Caterpillar

—Joseph V. Amato

3 Outperforming Sectors

Weekly Market Commentary
Winthrop Capital Management
June 14: In our Core Sector model series, we place sector bets by overweighting in exchange-traded funds that correspond to sectors of the S&P that we believe will outperform over a period. In the second quarter, we were overweight in healthcare, technology, and communication services.

Demand for the tech sector has remained elevated, with increasing consumer demand for PCs, gaming hardware, software, personal devices, and online-payment services. Revenue and earnings in the tech sector continue to impress. Balance sheets are strong, and debt is low within the sector.

Communication services is concentrated in social-media and entertainment companies. Covid has had a positive impact, as social distancing has increased our demand for social media and streaming entertainment. A lot of revenue from many of these companies is advertising-focused; [advertising] has faced significant headwinds through the pandemic. However, these businesses have succeeded in pivoting toward other media.

Companies in the healthcare sector have strong balance sheets, with a lot of cash for dividends and M&A. Demographic trends also help, with an aging global population. Demand is returning for elective procedures, drug sales, medical equipment, and diagnostics. Valuations are attractive.

—Gregory J. Hahn, Adam Coons

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