The Timeline of Transitory

By TRG Advisors on July 13, 2021

1. Trouble Taming the 10-Year. Treasuries rallied on a myriad of issues including peak growth concerns, lessening inflation expectations, short-covering, fears of the Delta Variant, and Treasuries continued relative advantage over other global yields. Investors who bet against transitory inflation with the expectations of higher yields scrambled to cover their shorts as the Treasury yields rallied, exacerbating the move through 1.30% on the 10-year. Investors are covering their shorts due to the continued descent in yields, which goes against the strongly held consensus that yields would rise concurrently with the reopening of the economy. The 10-year got as low as 1.25% mid-week, although it pulled back on Friday to finish the week above 1.30%. The market will look for any change of tone from the Fed next week as Chairman Powell testifies before Congress. Also notable is the Fed’s decision to increase the supply in the 3- and 10-year treasuries by $58bln and $38bln, respectively.
2. The Timeline of Transitory. Discussion around whether inflation is transitory or not continues. Many contributors to transitory inflation, including supply chain constraints and some commodity pricing, still have a long way to go before reaching levels of equilibrium. Companies continue to stress keeping a keen eye on the high demand and tightness of the supply chain environment. We believe this tightness for many industries will carry over into 2022 and lead companies to either increase prices or cut costs in order to maintain margins and bottom line.
3. Wages in Earnings Reports. Wages will likely be the stickiest contributor to rising inflation. Can companies who are forced to increase wages in order to attract employees maintain margins? Will they maintain margins purely from revenue of increased demand or will they also increase the price of their goods and services? Keep an eye on where companies look to cut costs to protect their bottom lines from being impacted by rising wages.
4. Tailwinds for Risk Assets. Above trend growth around 4-5%, continued inflation (transitory or not) and lower rates create a cocktail best served with investments in risk assets/equities. Continued rotation from value into growth shows a remarkable comeback in spread, now near 1% compared to 12% back in May.¹ The trend may be your friend at these current levels.
5. Prefer Reopen Stocks. We continue to lean towards the re-opening play. Cyclicals have exposure to secular growth where there is a substantial total addressable market. These companies continue to experience strong demand as consumers are eager to spend savings and stimulus on activities and new technologies.
6. Financials. Aside from yields moving lower, we are focused on owning special situation banks that are less yield curve dependent. Significant investment banking backlog with strong M&A deal market is expected to generate revenues in the back half of the year. Return of corporate buyback programs will benefit shareholders and much of the bad news is already priced in, with XLF P/E around 16x.²
7.  Improvement in U.S. Job Market. Nonfarm payrolls move up by 850,000, above 706,000 consensus. Payroll data also improved in May, but received mixed reviews due to higher unemployment rate. Unemployment rate of 5.9% vs 5.6% consensus. JOLTS reports continue to confirm there is a disconnect between the high number of job openings and widespread worker shortages. ³

Returns for Selected Indices ⁴

Disclosure

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¹Source: FactSet.
²Source: FactSet.
³Source: U.S. Bureau of Labor Statistics.
⁴Source: Bloomberg.