The stock market coasts toward the halfway point with the S&P 500 returning nearly 14%

Published Sat, Jun 12 20218:31 AM EDT

Stock investors are coasting toward the halfway point of the year feeling a mixture of contentment and confusion. Content because the S & P 500 has returned nearly 14% including dividends, after nudging slightly higher last week to a new record, already reaching the threshold of the average Wall Street strategist's year-end target. The cost for this 34% annualized gain in less than six months? Merely a few brief 3-6% dips and perhaps the occasional moment of consternation over some viral "meme-stock" pump jobs occurring around the edges of the market. The confusion is mostly about narrative dissonance, causing the popular playbook in wide use early this year to quit working as well. Exiting the first quarter the prevailing storyline was about rising bond yields, economic acceleration, swelling inflation and the cyclical and value stocks that had lagged for years, but were seen as the ideal vehicle to ride trillions in fiscal stimulus and pent-up demand. Strongest relative inflows of retail cash was into basic materials funds; heaviest outflows from tech. It was such a popular story the market couldn't allow it to come true right away, it seems. Since May 7, the prior record high for the S & P 500 before last week, the index closed at 4232. It finished Friday at 4247, about a third of a percent higher. Yet banks, industrials, consumer cyclicals as a group are all down since then. The deflationary plays have led, with software up 8% since the old S & P high and real estate investment trusts a new favorite destination of the hot money. The sector and style reversal is, of course, most closely tied to one of the most confusing turns, the rally in Treasuries that has compressed the 10-year yield to 1.45% from above 1.75% in June. This despite two straight blistering monthly inflation reports. There are surely valid explanations for the counterintuitive bond move. Bonds were more oversold at the end of the first quarter than they'd been in years, so this is partly pure mean-reversion and short-covering. Foreign investors are happy to capture higher US yields while hedging exposure to a weaker dollar. The Street seems to take the Federal Reserve fully at its word about patience and not reacting to near-term inflationary flareups. Bank of America last week noted private pension funds are fully funded for the first time in years, driving them to lock in portfolio values by rotating into fixed-income assets. For sure, the markets might be registering that we've passed or are about to pass the moment of "peak acceleration" in GDP, corporate-earnings and, yes, inflation. And perhaps the uptick in Covid cases in several big countries, the Chinese shipping logjam, rampant supply bottlenecks, a short-term climax in housing demand, approaching decline in the fiscal impulse and widespread labor shortages are lining up as potential restraints on the recovery's velocity in the near term. Volatility gauges are sagging, hinting at a sleepy summer tape. There's a chance the economic data will carry low stakes and few policy implications until September. That's when kids go back to school, enhanced jobless benefits lapse, the easy comparisons with the 2020 lockdown quarters end, the Fed will have had time to set the stage for its next move, and more Americans might opt to re-engage with the labor market to take some of the 9.3 million open jobs, in a deferred return to normal. What to do about it Those are the whys, but the more pressing matter is what to do about it, if anything. For now, this subtle shift in market character seems more like a bout of mean reversion than a decisive inflection point – the "reflation trade" favorites working off overbought and over-loved conditions while big-growth and speculative-tech stocks played some catch up after growing less expensive and crowded than they were 8-10 months ago. The longer-term uptrends in financials and industrials relative to the S & P 500 remain intact even after their recent loss of altitude. Likewise, with the 10-year Treasury yield: While its recent slide has caught many offside, the run from 0.5% to 1.7% was so steep that the pullback still appears as a digestion rather than a breakdown, though it's becoming a pretty close call. Consumer discretionary shares appear a bit more pressured, with housing-related and some retail names struggling in a way that suggests a mid-cycle backdrop beyond the "good as it gets" point for them. The overall market continues to be supported by a constant alternation among sectors and styles, a largely sideways eight-week downshift that feels only slightly more like traction than slippage, with cumulative market breadth at a record high even as momentum has waned. Yet the day to day the leadership has been fickle and confounding, making the standard "growth or value" debate seem simplistic and less relevant. Value is less cheap, and growth not as over-owned, as they were several months ago, leaving each in a grayer area. There are, don't forget, plenty of other ways to break down market themes. To almost no notice at all, "quality" large-cap stocks just nosed ahead of the leading momentum basket for the past year and had a far smoother ride doing it. Quality is about fundamental corporate strength – high and stable profit margins, strong balance sheet – and it tends to lag in the initial burst off a major market low and earnings collapse. But we're now 15 months past the moment of maximum pain now. The iShares MSCI Momentum ETF , meantime, just reshuffled its holdings to become profoundly top-heavy with value names. Financials are more than 30% of the fund and it is now underweight tech relative to the S & P 500. Doesn't make it a bad bet, but a very different one than the common understanding of momentum. Corporate abundance is likely to be a durable feature of this market, with earnings gushing in at a record pace, debt almost unprecedentedly cheap and plenty of cash on hand to invest in capital, share with investors and spend on acquisitions. "Total shareholder yield" combines share-buyback and dividend disbursements and owning stocks that rank highly on this score has worked well, both recently and over very long time periods, as these ETFs show. (The Cambria Shareholder Yield strategy skews toward smaller companies than iShares Dividend & Buyback ETF , accounting for at least some of the recent performance gap.) The rest of the world is starting to jostle for attention from investors too, major European markets finally breaking to new highs and economies abroad with more of their reopening impetus ahead of them than in the U.S. The MSCI World ex-U.S. index is just poking to a new high for the first time in almost 14 years. It's fair to note that the majority of flows this year have been to foreign rather than U.S. equity funds, but that in itself doesn't mean overseas markets can't reward these newer investors over time after so long in abeyance.

Traders at the New York Stock Exchange, June 2, 2021.

Source: NYSE

Stock investors are coasting toward the halfway point of the year feeling a mixture of contentment and confusion.

Content because the S&P 500 has returned nearly 14% including dividends, after nudging slightly higher last week to a new record, already reaching the threshold of the average Wall Street strategist's year-end target.

The cost for this 34% annualized gain in less than six months? Merely a few brief 3-6% dips and perhaps the occasional moment of consternation over some viral "meme-stock" pump jobs occurring around the edges of the market.

The confusion is mostly about narrative dissonance, causing the popular playbook in wide use early this year to quit working as well.

Exiting the first quarter the prevailing storyline was about rising bond yields, economic acceleration, swelling inflation and the cyclical and value stocks that had lagged for years, but were seen as the ideal vehicle to ride trillions in fiscal stimulus and pent-up demand. Strongest relative inflows of retail cash was into basic materials funds; heaviest outflows from tech.

It was such a popular story the market couldn't allow it to come true right away, it seems.