Warning Flags?

The small-cap Russell 2000 Index managed a small gain, but most of the major equity indexes ended last week modestly lower. Investors weighed some encouraging economic data against worries about supply chain challenges, elevated valuations, and concerns over how stocks would respond to an eventual tightening in monetary policy. Energy shares within the S&P 500 Index recorded solid gains on the back of rising oil prices, while strength in auto-related shares boosted consumer discretionary stocks. The small materials and utilities sectors lagged.

The week began on a down note, which was attributed in part to moderating stimulus hopes. On Sunday, Democratic Senator Joe Manchin said he would support an infrastructure spending package of around $1.5 trillion, far less than the $3.5 trillion that the more progressive members of Congress have proposed. Manchin, whose vote will be crucial for the bill’s passage, also stated that he believes congressional leaders should take their time with the decision, as opposed to forcing the issue. To help fund the new package, Democrats are seeking to raise the corporate tax rate to 26.5%, up from the current 21%, while also raising the top capital gains tax rate from 20% to 25%—a smaller increase than anticipated.

Investors also pondered a few significant data surprises during the week. On Tuesday, the Labor Department reported that core (less food and energy) consumer prices increased 0.1% in August, below consensus expectations for a 0.3% increase and the smallest gain since February. Declines in airfares and used car prices drove much of the shortfall. On Thursday, the Commerce Department reported that August retail sales outside the volatile auto sector jumped 1.8%, defying consensus expectations for a small decline. A gauge of factory activity in the New York region, reported Wednesday, also came in well above expectations.

Tuesday’s mild inflation data appeared to drive a rally in bond prices, pushing the yield on the benchmark 10-year U.S. Treasury note to its lowest intraday level since August 23. Many investors seemed to believe that the benign inflation report won’t have significant implications for Federal Reserve policy (i.e. tapering) given the outsized importance of the labor market recovery. The pending increase in taxation for business owners, as well as the seeming inevitability of tightening monetary policy could be warning flags for economic slowdown. That said, the strength of that warning (not to mention the timing of the potential effects) needs to be discerned carefully. Such discernment is paramount in times of misinformation, much like Joshua and Caleb, the two spies who went into the promised land and brought back a good report to Moses, believing that God would help them succeed, while the other ten warned Moses not to proceed. Our trust must remain beyond just that which we see.

Sources: Yahoo Finance, Reuters.com, and JP Morgan Market Insights

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