Market Commentary for the week ending July 16th, 2021
- Small stocks suffered steep losses for the week while bond yields continued to ease.
- Retail sales and inflation both jumped in June more than economists’ forecasts.
- Gold and real estate stocks were higher helped by the strong inflation report.
The Leverage in Corporate America
Leverage is simply a measure of total loans and liabilities (debts) relative to total assets or market value. In other words, it shows us how much money a company has borrowed to fund its operations relative to the size of the company. For example, if Apple (AAPL) borrows $100 million it is of no concern given their massive size as compared to a very small company borrowing the same amount.
The accompanying graph shows the total liabilities as a percent of market value for both large stocks, every stock in the S&P 500, and for small stocks, every stock in the Russell 2000 index. This graph highlights two interesting facts.
Source: www.YCharts.com; excludes Financial sector stocks
The first fact is that small stocks are much more highly leveraged than large stocks. This means that higher interest rates would be more costly and burdensome to smaller companies and less so for larger companies. This may help explain why small stocks fell sharply this week if investors are fearing the possibility of higher interest rates.
The good news for both small and large companies is that they are less leveraged today than they were at the end of 2019 pre-pandemic. This suggests that corporate America is better positioned to handle any economic shocks or higher interest rates.
This Week’s Performance Highlights
Investors were given a wide range of data to digest last week including the start of the quarterly earnings season as well as multiple economic reports suggesting the economy is possibly overheating. This all generally fueled some selling pressure especially among smaller company stocks.
- At the close of the week large U.S. stocks were off -1.0% as measured by the S&P 500 while the Dow Industrials lost just half that. The tech-heavy NASDAQ Composite suffered a steeper loss of -1.9% in spite of some of the largest tech stocks such as Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOG) all trading higher.
- Small U.S. stocks were hit very hard falling -5.1%.As discussed above, this decline could be a result of investors’ fearing interest rates may move higher sooner than originally expected increasing the borrowing cost for these more leveraged companies.
- Three sectors moved higher for the week with Utilities leading the way gaining +2.6% while Energy stocks fell sharply down -7.9%. As the accompanying graph shows, the Energy sector has been on a wild ride since the pandemic outbreak falling sharply early on and then surging when the first vaccine was reported. The sector remains the best performer in 2021 in spite of the week’s decline.
- International stocks were more mixed with developed country markets down -1.6%. The Eurozone region was the worst performer impacted by sharp declines in Spain and the United Kingdom down -4.2% and -2.6% respectively. Emerging markets held up relatively well gaining +0.1% for the week helped by strength in Hong Kong and Brazil.
- Real estate and gold, both considered good hedges against inflation, gained on the week up +0.7% and +0.1% respectively. Commodities were off -0.6%.
- Bond prices inched higher once again even though the report on inflation showed prices increasing rapidly suggesting interest rates may need to move higher. The yield on the 10-Year U.S. Treasury bond closed at 1.294%, a new recent low, compared to 1.360% the week before.
Virgin Galactic (SPCE), the company that took 4 passengers, including its billionaire founder Richard Branson, and two pilots to space in the first flight of its kind demonstrating the potential for space tourism. This successful flight was followed by a weeklong drop in its stock price of -38.6% as illustrated in the accompanying graph on the far right. Investors may have been happy about the flight but were clearly displeased with the company announcing after the flight plans to sell an additional $500 million of stock to raise cash. It may also be that the exciting story of the first flight has passed and now reality is settling in that the company needs to generate a profit which it has never done.
The largest divorce settlement in the United Kingdom’s history was reached with the Russian billionaire oil oligarch Farkhad Akhmedov paying his ex-wife $186 million. It brings to an end a multi-year legal battle that his ex-wife funded via a litigation finance group that will receive $103 million of her settlement!
Retail sales came in much stronger than expected up +0.6% in June versus economists’ expectation of a -0.4% drop. Restaurants and bars posted some of the biggest gains as consumers continue to get out of the house flush with cash from the massive government stimulus. Auto sales were one of the few weak spots, down -1.3% for the month, due to a continued shortage of inventory. Offsetting some of this report’s good news was a revision lower for May sales to a decline of -1.7%.
Consumer prices surged +0.9% in June also coming in much higher than economists had forecast. Prices for food, energy, clothing, travel, and more all rose sharply but autos saw the biggest price increase soaring +10.5% on the heels of big gains already this year. Year-over-year prices are up +5.4% as the accompanying graph illustrates. The Federal Reserve, our country’s inflation watchguard, continues to say the rapid increase in prices will slow to normal levels by next year although they have been surprised by the magnitude of price gains reported.
The Producer Price Index (PPI), a measure of wholesale inflation, also jumped more than expected up +1.0% for the month and is now higher year-over-year by a staggering +7.3%. This represents one of the biggest annual gains since the 1980’s.
Industrial Production, a measure of output by manufacturers, utilities, and the mining sector, increased by +0.4% in June. Excluding autos, which are being held back by a shortage of computer chips, production gained a more impressive +0.8%.
Initial jobless claims for the week came in at another post-pandemic low of 360,000. Companies though continue to struggle to find employees with 1.8 million Americans saying the a staying at home because unemployment benefits provide enough money to get by for now according to a recent poll.
Upcoming Economic Reports
- Housing Starts
- Existing Home Sales
- Index of Leading Economic Indicators
- Initial Jobless Claims