Before The Bell - The first three sessions of this week had investors searching for some news to drive trading, but there was none to be found, as both the economic and earnings calendar were very light. However, that changed this morning at 8:30 A.M. EDT when we received two reports from the Labor Department. Specifically, we learned that initial weekly jobless claims fell to another pandemic low, coming in at 376,000. Meantime, consumer prices, which have been closely watched for signs of inflation, rose 0.6% month to month and 5.0% year over year in May, the latter was the biggest increase since August 2008. The expectations called for a sequential increase of 0.5% and a year-to-year gain of 4.7%. The equity futures, which were mixed leading into the releases, have stayed on the same course. 

The major averages have traded in a tight band for much of this week, but the final hour of yesterday’s session did see the selling pick up, with some investors likely a bit nervous ahead of the aforementioned pricing data. The Dow Jones Industrial Average, the NASDAQ Composite, and the broader S&P 500 Index slipped 153, 13, and eight points, respectively. We saw some sector rotation on display. There was some movement out of the cyclical sectors (i.e., financial, energy, materials, and transportation) and into the higher-growth areas, including the technology group. It should also be noted that following news of the Biogen’s (BIIB) Alzheimer drug candidate recently gaining regulatory approval, the healthcare stocks, particularly shares of the biotech companies, are garnering more interest from Wall Street.

So what drove yesterday’s rotation? The catalyst was the drop in the yield of the 10-year Treasury note, which settled yesterday at 1.489% (it has since rebounded to around 1.53% this morning following the economic data). As noted, this pushed investors into the growth areas, but we don’t think this is a sign that inflation is not an issue. Our sense is it was investors recognizing the underperformance of bonds versus the S&P 500 stocks so far this year and wanting to increase their fixed-income exposure at a rather inexpensive price. It also should be noted that with the sharp run-up in the U.S. stock market since its 2020 coronavirus-driven nadir, many of the pension plans at now fully funded. Plan managers may be seeing an avenue to preserve these gains by adding more fixed-income to their portfolios, which offer more safety than equities, especially with valuations looking quite frothy these days; the S&P 500 Index came within a few points of establishing another record high yesterday.

Looking ahead to the session at hand, the two economic reports from the Labor Department are grabbing the attention of Wall Street this morning. And with that, we think the cyclical issues will again come into focus for investors. Today’s reports show that the economy is strengthening and prices are rising. In fact, the price of crude oil topped the $70-a-barrel mark for the first time since 2018. In this environment, we would continue to give the value-oriented cyclical stocks a very close look. Even if the inflation situation does prove transitory like the Federal Reserve thinks, the central bank has already begun to taper some of its pandemic-driven bond-buying initiatives. This, along with higher prices, may not be an ideal backdrop for many high-growth stocks, especially some of the emerging technology names that skyrocketed during the coronavirus pandemic. Conversely, the recreation and travel and leisure stocks may get a big boost from economy fully opening, as more vaccinated people return to more normal living.

Before the open, the equity futures are suggesting that investors are reversing course from yesterday, and will likely be rotating back into some of the cyclical sectors. That said, the market, in general, seems to be trading like this is peak inflation, and the Federal Reserve’s prediction that inflation is transitory will play out in some form later this year. Wall Street still appears to be adhering to the age-old adage, “don’t fight the Fed.” Stay tuned.  – William G. Ferguson

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.