Stocks Move with the News
It was a rollercoaster week on Wall Street, as investors dumped stocks on Monday as concerns over the possible collapse of China property company Evergrande and overall worries about China’s crackdown on indebted firms unnerved traders. Evergrande is the largest property developer in China, and its financial troubles could lead to a domino effect particularly in Asia. The market had closed below its fifty-day moving average on the previous Friday, a sell signal for some chartists, and traders pulled $28.6 billion from U.S. equity funds over the first three days of the week, the most since February 2018. Stocks then staged a rally Wednesday afternoon through Friday after Fed officials signaled no immediate removal of its easy money policy. Tech stocks underperformed on Friday, perhaps linked to China’s crackdown on crypto-related transactions, alternatively rising interest rates may have caused some pressure on those high-growth, high P/E stocks. Financial stocks rose as the 10-year U.S. Treasury yield reached its highest since July at 1.46%. For the week, both the S&P 500 and the Russell 2000 gained 0.5% while the tech-heavy Nasdaq finished flat.
At North Star, we are not overly concerned with the recent modest rise in the 10-year rate, but a break-out above 1.75% could be troublesome, as the elevated equity valuations are more easily justifiable if rates remain at these historically low levels. At the same time, it is important to note that rising rates don’t necessarily lead to market selloffs, and contrary to a commonly accepted misperception, are not a reason to rotate out of small-cap stocks, as our recent white paper (linked here) illustrates.
The chart above highlights that in 2021 the yield on the 10-year Treasury rose rapidly for three months, trended lower for four months, and now seems to have entered another phase of increasing rates. An optimistic interpretation of the trend would be that the economy will continue to recover as the pandemic subsides over the next few months. The most recent data indicates that the number of new cases and hospitalizations have been declining at double-digit rates, although daily deaths remain elevated. The lower number of new cases and hospitalizations should lead to a downturn in deaths over the next few weeks and expanded vaccinations should further improve the trends.
Debating a Default
Politics will be in focus as the showdown over the government debt ceiling is likely to ramp up. Whereas past U.S. government shutdowns or debt ceiling debates have had no consistent impact on the markets, specific industries dependent on government contracts have experienced heightened volatility. Thursday is the deadline for the Senate to pass a bill to avert a government shutdown. Separately, the House is expected to vote on the $1.2 trillion infrastructure bill on Monday, and the debate on the additional $3.5 trillion spending package will rage on.
The economic calendar includes updates on durable orders, consumer confidence, pending home sales, GDP, and construction spending. On Friday, the BEA reports on personal income and spending for August could provide some insight into consumer behavior during the early stages of the Delta variant spread.
At North Star, we plan on continuing our behavior of “consuming” Chicago Bears games, despite reduced expectations for victories after Sunday’s 26-6 defeat in Cleveland. On a positive note, the Chicago Sky looked terrific in back-to-back playoff victories over Dallas and Minnesota in WNBA action.
Stocks on the Move
+17.01% Evolution Petroleum Corporation (EPM) explores for and produces oil and gas. The Company focuses on acquiring established oil and gas fields and applying specialized technology to increase production rates. There was no significant company news last week; however, the company did report a revenue beat and 50% dividend raise the week prior.
EPM is a 1.4% position in the North Star Micro Cap Fund and a 3.5% position in the North Star Dividend Fund.