Every January we publish an annual outlook where, among other things, we offer some views about what might be in store for markets and the economy in the year ahead. Last year we – along with the rest of the known world – got kind of sideswiped on this. All those predictions in the middle of January were upended by the coronavirus pandemic that followed shortly thereafter. The year turned out to be nothing like what anyone would have reasonably thought. And even if you could have guessed that a virulent disease would sweep the globe and bring the world economy to its knees, you would be forgiven for not guessing that world stock markets would stage a rally for the ages in its wake. Or that the country where the pandemic began – China – would snap back so quickly that its actual GDP growth for 2020 was barely different from where economists had predicted it would be before the pandemic hit. Or any number of the year’s other bizarre twists and turns.

Covid, climate, cyber…of the big three scourges currently stalking the globe, Europe was at least spared this week of any known large-scale cyberterrorist attack. It was a bad week regarding the other two, however. The delta variant continues its ruthless stalking of a population still having trouble reaching its vaccination targets. If last Sunday’s UEFA championship match in Wembley Stadium, overflowing with more than 60,000 humans frenetically cheering on Italy or England, turns out to be the superspreader event many expect then the Covid numbers are likely to be even worse in the weeks ahead. Meanwhile a devastating climate event has left Germany with massive economic damage from flooding and a death toll already surpassing 100, with hundreds more missing and more rains expected in the days ahead.

Recovery, Interrupted

Europe started the year as an object of desire for global investors – a rather rare state of being for a region that has chronically underperformed US equities over a very long time. The chart below shows the relative performance of the Stoxx Euro 600, a regionwide benchmark equity index, against the S&P 500 for the past 30 years. Over this time the US index retuned more than double the level of its European counterpart.

This chronic record of underperformance, exacerbated by Europe’s prolonged financial crisis during the first half of the 2010s, left shares of many of the region’s best companies significantly undervalued relative to their high-flying US peers. As 2021 got underway many investors saw this as an opportunity: cheap, high-quality stocks on the cusp of a robust economic recovery, with a potential added boost coming from an appreciating euro against the US dollar. Regional bourses like the German DAX outperformed the S&P 500 during the first couple months of the year.

But the region’s botched handling of the initial vaccine distribution process, the persistence of high daily case rates for Covid and a euro rally that failed to materialize all contributed to throwing a wet blanket on the Euroequities revival party. A return to lockdowns of varying degrees of severity occurred across much of the continent. High-end industrial production, which is a much bigger component of Europe’s economic output than is the case in the US, flagged as some of its key export markets had to deal with their own ongoing Covid battles. Since the middle of last month US and European stocks have sharply diverged, as seen in the chart below.

Tech Envy

One of the prominent differences between benchmark indexes for US and European stocks is the much smaller percentage of technology companies in the latter. Technology shares comprise just 7.2 percent of the Stoxx Euro 600. The S&P 500’s technology sector – along with Alphabet, Facebook, Amazon, Netflix and Tesla (which are in other sectors but commonly thought of as tech companies) makes up about 46 percent of that benchmark’s total market capitalization.

That difference matters in many ways, not least of which is that in the US the megacap tech platforms have become something of a safety valve – a defensive play in some ways not unlike what sectors like utilities or defense manufacturers have traditionally been. In the past month or so these companies have accounted for almost half of the total price performance of the S&P 500. It is thus not unduly surprising that European markets have been unable to keep up over this time period.

Is Europe still a good bet? There should still be some upside to the recovery story as the more draconian social distancing measures come to an end. The region is likely to experience less inflation in the months ahead than the US, to the extent that trend stays in focus. But that long-term price performance chart is sobering. Perhaps the US will not be able to outperform Europe indefinitely. But figuring out when the mean reversion kicks in is likely to be a thorny problem.

Yes, it’s another column about the bond market after a few weeks where we turned our attention elsewhere. But we’re still trying to make sense of a trend that we wrote about a few weeks ago that has only gotten stranger since – and we think it is one of the more important stories out there deserving of our attention. We’ve updated the chart from that earlier commentary here below.

Inflation and Yields

The above chart shows the long-term relationship between the yield on the 10-year Treasury note and inflation, represented here by the core (excluding food and energy) Consumer Price Index. Over time this relationship tends to be relatively stable; the natural place for nominal bond yields, according to the finance textbooks, is at some premium to expected inflation with the size of the premium subject to various economic factors. At various junctures this relationship may not hold; for example, when market shocks drive up demand for safe haven assets (for example September 2011 and January 2016) or when the Fed abruptly pivots on its monetary policy direction (for example January 2019 and March 2020).

Starting in late 2020 inflationary expectations started to build as investors factored in the variables of successful Covid-19 vaccines, an expected resulting surge in consumer demand and ongoing supply chain problems impeding the ability of businesses to fully satisfy this rebound in demand. Quite rationally, interest rates began trending up. This trend gathered steam in the first few months of 2021 as the additional variable of unprecedented levels of fiscal relief and stimulus from the new Biden administration got thrown into the mix.

Throughout this period the official stance of the Fed was that higher inflation would be a temporary phenomenon related to the immediate post-pandemic environment, and that things would quickly settle back down to a world of long-run inflation in line with the central bank’s target rate of two percent. The go-to narrative among the financial chattering class in the first quarter of 2021 was that the bond market wasn’t buying the Fed’s assurances; that inflation was a bigger problem than just a couple months of anomalous supply-demand dynamics and that the Fed would eventually have to play catch-up.

Inflation and Growth…Or Not

That narrative appears to have been turned on its head. This week the 10-year Treasury fell below 1.3 percent, continuing the downward trend that followed the June FOMC meeting. Now it seems to be the bond market saying that inflation is no big deal, while at least one faction of the Fed – according to the FOMC minutes released earlier this week – is becoming more vocal about the possibility that monetary tightening may need to happen sooner than planned. It’s like one of those switcheroo movies where the mom and her 13-year old daughter wake up to find themselves in each other’s body.

Lurking in the background of all this is the specter of the kind of economy we experienced in the 2010s, characterized by perennially low growth, below-trend inflation, low unemployment with stagnant wages and dependence on the Fed for easy monetary policy. If the collective wisdom of the bond market is that once the dust settles from all the pandemic-related distortions then this is the world we’re going back to, then yes – a 10-year yield around 1.3 percent and 30-year rates below two percent make a certain amount of sense. The potential growth component from population and demographic trends hasn’t improved – the rate of population growth continues to shrink as does the percentage of the population in the labor force. Productivity, the only other source of sustainable economic growth, has yet to demonstrate a meaningful reversal of structural weakness.

So the bond market may be reflecting peak growth and inflation. Or, the recent trend may be due to temporary technical factors and indicative of nothing as far as longer-term dynamics. Either way, it’s a pretty good bet that this won’t be our last piece on the subject.

Commodities have been one of the big stories for the first half of this year. For much of this time so-called real assets from crude oil to copper to lumber rose together, benefitting from the tailwind of the reflation trade that also saw bond yields rise and stock market mojo switch from growth to value. Cracks in the reflation trade started to appear in May, as key industrial commodities including the aforementioned copper and lumber peaked. Oil, however, kept on keeping on. The chart below illustrates the diverging fortunes of crude and copper since mid-May.

A Really Weird Year (and Decade) for Crude

The persistence of oil’s strength has some traders betting that barrels of the viscous substance will hit $100 before the end of the year, a level not seen any time since before the great energy price plunge began in 2014. That would be one of the more remarkable comeback stories for any asset. Recall that as pandemic lockdowns got underway last year the price of crude oil plunged more dramatically than just about anything else. At one point near-term West Texas Intermediate crude futures actually traded below zero. “Take my crude…please!” went the refrain when a supply glut meant there was literally no place for a buyer to store the stuff.

At the peak of the pandemic one could have almost felt sorry for the oil producer nations that make up the so-called OPEC Plus group, which consists of the members of the old OPEC cartel, the scourge of the 1970s, along with Russia and other major producers. But the pandemic produced a couple developments that may make that elusive $100/bbl price more likely than not.

First, the group reached an agreement to cut production in April 2020, so that effectively it is sitting on about six million barrels per day of supply that remains in the ground rather than going to market. That agreement is currently up for discussion, which we’ll get to in a minute. The second development was a dramatic curtailing of investment in shale oil fields like the Permian Basin of west Texas. US-based unconventional production ramped up in the second half of the 2010s and was a major factor in keeping a lid on global prices. The pandemic hit these developers hard, and access to financing all but dried up. Even as the economic tea leaves pointed to a likely surge in demand on the other side of the pandemic, investors have been looking farther ahead to structural changes in the energy industry benefitting green technologies and discounting traditional fossil fuels. Permian’s loss is OPEC Plus’s gain, at least for now.

What Now?

Back to that 2020 production cut agreement. The OPEC Plus group was supposed to hammer out a deal yesterday that would, observers expected, see a gradual increase in daily production between now and the end of the year – perhaps in the area of 500,000 barrels per day (out of that total six million or so being held in the ground). The idea was to bring back enough production to help meet rising demand, but not so much as to significantly dampen prices.

The members failed to reach agreement yesterday, and are still at it as we write this today. Pushback from the United Arab Emirates and Russia, both of which would like to ramp up more production sooner, is holding back a final deal. At the same time other officials worry that if holding back production does succeed in getting to $100, that could change investor sentiment to finance and thus bring back more supply from the US shale fields, potentially eating into OPEC Plus market share and depressing prices. There is also the concern that the return of lockdowns around the world in response to the delta variant of the coronavirus could throw a wrench into near-term demand dynamics.

The Last Boom

However things play out in the short term, the longer-term outlook for fossil fuels is going to hinge mostly on the pace of transition from traditional energy sources to green technologies, a transition that is steadily gaining momentum. We wrote a few weeks ago about shareholder activism and regulatory directives affecting the exploration plans of major oil producer like Exxon Mobil and Royal Dutch Shell. The economics of technologies like solar and wind are improving and fast becoming cost-competitive alternative energy sources. While the dynamics of short-term supply and demand may be enough of a tailwind for crude prices to party like it’s 2014, the structural changes at play would suggest that there may not be too many booms left in the boom-and-bust cycle for this commodity.

We don’t write much about Japan in our weekly commentaries, because quite honestly in most weeks there are other, more important things going on in global capital markets that we believe merit our attention. Every now and then, however, a story catches our eye and reminds us that there is always a valuable lesson to be had in considering the case of Japanese equities.

That lesson, quite simply, is that “stocks always go up in the long run” is not a universal law on par with gravity or Schrödinger’s wave function. To this very day the Nikkei 225, which you can think of as Japan’s version of the S&P 500, languishes some 25 percent below its all-time high reached at the end of 1989. You read that right – 1989. Japanese equities hit an all-time high years before anyone in the world even knew who Britney Spears was. Here’s the chart as proof.

The story that caught our attention this week concerns Toshiba, one of the bluest of Japanese blue chips with a 145 year history and a sad reminder of some of the underlying structural problems that help explain the country’s woeful long-term equity price performance.

April Showers Bring No Flowers

Back in April two things happened of note: the Nikkei 225 crossed the 30,000 level for the first time since 1990 (see chart above) and Toshiba chief executive officer Nobutaki Kurumatani abruptly resigned from office. Long-suffering Japanese investors cheered the Nikkei news, but the Toshiba developments suggested how fragile the recent bullish sentiment might be. Kurumatani’s resignation came after a series of long-festering scandals surrounding the company starting with the discovery of widespread accounting fraud in 2015. Two years later its US nuclear business collapsed, leading the company to the edge of bankruptcy. A $5.4 billion emergency equity infusion rescued the company, deemed by Japanese regulators to be of the highest strategic importance. But Toshiba continued to flounder, selling off valuable assets like its semiconductor chip business in efforts to stay afloat.

Barbarians At The Gate

That $5.4 billion equity infusion was no free lunch for Toshiba, and it set the stage for the extraordinary set of events that happened this week, leading to the decision today at the annual general meeting of shareholders to oust the chairman of the board Osamu Nagayama, a longstanding pillar of Japan’s corporate establishment. The 2017 equity infusion brought a bevy of foreign institutional shareholders into the company, including a number of activist investors who pushed for increased transparency and better governance to clean up the company’s image tarnished by its earlier scandals.

An explosive independent report issued recently detailed the extent to which Toshiba and one of its key government regulators, the Ministry of Economy, Trade and Industry (METI), colluded on measures to suppress activist shareholders. For many shareholders, activist or not, the report revealed just how little has changed in “Japan, Inc.” in terms of shoddy governance, improper regulatory protection and practices designed to entrench the status quo. The independent report that preceded today’s AGM could just as well have been written in the 1980s, back when METI was the formidable institution then known as MITI (Ministry of International Trade and Industry), the scourge of foreign competitors trying to break into the Japanese market.

Lessons Learned, Or Not

The ironic twist to the Toshiba story is that its next incarnation may well be on the auction block for sale to private equity bidders. One such attempt, by private equity firm CVC, failed in April (and directly led to the resignation of then-CEO Kurumatani). That bid, though, appears to have paved the way for other foreign firms to compete for the prize – such as it is – of one of the most high-profile Japanese firms ever. Such an end would be a major blow to the Tokyo Stock Exchange, and more broadly to the image of better business practices that former Japanese prime minister Shinzo Abe touted as one of the key pillars of his “Abenomics” program.

Whether anyone has actually learned a useful lesson here remains to be seen. There is much chatter this week about l’affaire Toshiba being the wake-up call Japan needs to justify a sustained improvement in its economic and market fortunes. Yes, but there have been many wake-up calls before, both before and after the Nikkei 225 peaked around 39,000 on December 31, 1989. For the time being, that Nikkei 30,000 level breached in April still seems awfully fragile.

The press conference following a Federal Open Market Committee (FOMC) meeting can be a pretty tedious affair, with carefully crafted Fedspeak answers to the predictable questions lobbed by financial journalists. But Fed chair Powell did say one important thing on Wednesday, very clearly and without nuance. “Dots do not represent policy decisions” he said. The dots referred to here are the Summary of Economic Projections (SEP) estimates each member of the committee makes about future economic and interest rate trends. This was of considerable interest to the attending journalists and to markets at large, because a few of these dots had shifted notably since the last SEP go-around back in March. Specifically, the median outlook for core inflation this year drifted up to three percent from 2.1 percent (though the long-term inflation outlook didn’t change).

Of more direct market consequence, the median “dot plot” around the Fed funds rate in 2023 had shifted to suggest two rate hikes that year from the zero lower bound. That’s newsworthy! In his comment Powell was trying to remind the journalists, and the market, that the dots are individual estimates and do not in any way denote an actual policy decision. 2023 is a long way from now. Even the very best and brightest minds at the Fed have essentially zero knowledge about what the world is going to look like then.

Reflation in Reverse

Powell’s measured comments, of course, had no impact whatsoever on the market’s hot take that the transition away from easy money has started. The principal victim of this hot take has been the reflation trade that propelled beaten-down value stocks, commodity prices and bond yields ever higher through much of the year to date. The chart below shows the immediate effect of the FOMC meeting and the dot plots on value stocks.

What Actually Changed, Though?

There is something inconsistent about the market’s hot take, though, which leads us to think that we may be heading into an environment characterized more by back-and-forth volatility than by a solid directional move away from the reflation trade. Recall that throughout this entire period the Fed has actually been resolutely consistent on one key point: whatever inflation we are likely to see in 2021, perhaps spilling into early 2022, is going to be temporary. And there is some evidence to support that view. In recent weeks we have seen a distinct pullback in key industrial commodities prices. Bond prices have stayed firm through a series of higher-than-expected increases in producer and consumer prices. And the US dollar, which tends to weaken when inflationary expectations go up, has also gained strength. The chart below illustrates these trends, all of which began well before this week’s FOMC meeting.

Now, these trends may or may not be indicative of anything longer-term. But they are all consistent with the Fed’s oft-stated expectation that the inflation arising from current asymmetries in supply and demand variables will iron themselves out in due course. Significantly, if that is the case then it would also be the case that Fed policy (i.e., low rates for longer) would not be unduly threatened by a structural change to higher inflation. Meaning…potentially no change in policy. Meaning that those dot plot shifts in the SEP this week are just what Powell said they are – simply estimates with no real implications for future policy decisions. Less signal, more noise.

It may take awhile for the market to arrive at a consensus narrative about what this all means for different asset categories. In the meantime, though, it would not surprise us to see more sharp movements back and forth as short-term triggers react without thinking to whatever headlines come out of the daily news cycle. A summer of more volatility, perhaps.

There is a reason why we are constantly telling our clients that short-term movements in the market are unknowable. You know that some big piece of news is coming out in a couple days that could have major economic implications. You assume that prices of stocks, bonds and other assets will react accordingly, rationally, based on your assessment of whatever the news turns out to be. Then the news comes out, and the market reaction is completely different from those rational expectations you harbored. Welcome to the world of the short term, where everything is possible and all that is real melts into thin air.

Sell the Rumor, Buy the News

This week’s piece of news, of course, was the May report for the Consumer Price Index. The much-anticipated report, released Thursday morning, showed consumer prices rising five percent, year-on-year, with the core index excluding the more volatile categories of food and energy increasing 3.8 percent. The core CPI increase was the largest since June of 1992, twenty-nine years ago.

Now, one might think that the first casualty of an inflationary spike would be nominal bond yields, which would adjust upwards to compensate for the loss of purchasing power implied in higher consumer prices. What we got instead was the continuation of a rally in bond prices making this week the best performance for US Treasuries since the beginning of the year (remember that bond prices and yields move in inverse directions; i.e. an increase in prices means a decrease in yields.)

The chart below shows the five-year relationship between the core CPI and the 10-year Treasury yield.

Why don’t bond investors care more about this hotter-than-expected inflation report? Long-time observers of the market will turn to one of their favorite old saws: you sell the rumor and buy the news. If you look at the above chart, you will see that the 10-year yield (the blue line) started rising steadily in the second half of last year, and then really took off in the first couple months of this year. That was the “sell the rumor” stage. By the time the first really big jump in inflation happened, in April, the selling had largely played out. The big theme this week, even as the May number surpassed the April CPI, was that “inflationary expectations have peaked.” The news is confirmed, onto the next thing.

But For How Long?

Maybe the bond market is starting to actually believe what the Fed has been saying for months: that this bout of inflation is temporary and consumer prices are likely to peak sometime over the summer. There is some good evidence to support the Fed’s position. An unusually large component of this month’s price increase comes from sales of used cars. This reflects an unusual combination of factors: pent-up demand from consumers coming out of the pandemic with lots more household income to spend, and supply constraints from global supply chain disruptions and a worldwide shortage in semiconductor chips. The Fed’s reasoning is that these kinks will work themselves out without creating lasting structural problems.

They may be right. But their entire frame of reference is the economic growth cycle of the 2010s, characterized by modest increases in economic output, persistently low inflation and a continual need for easy monetary policy even years into what became the longest economic expansion on record. If we indeed are to go right back to that world then the Fed is doing all the right things now, buying $80 billion worth of bonds every month and keeping short-term interest rates at zero even while the economy runs at its hottest rate in several decades. The eye-popping inflation numbers we are seeing now will fade into oblivion and nobody will pay attention to the monthly CPI reports.

They may also be wrong. That chart above showing a 10-year yield of 1.46 percent and a core inflation rate of 3.8 percent doesn’t make any kind of sense in a world where that relationship becomes structural. Something would have to give – and that “something” would be the Fed’s easy money. With the end of easy money would come the end of the “Fed put” – the implied promise to bail out investors from sustained damage to asset prices. And that would be a very different world indeed.

There is a lot of economic news out there to digest. Unlike the first half of the year, which seemed to be more about the capricious tradewinds of momentum and less about the underlying fundamentals, what happens in the second half could largely be a function of those monthly jobs, inflation and related numbers. They will be influencing Fed deliberations on monetary policy as well as guidance from corporate management teams on how we should understand the impact of higher prices, at both the wholesale and retail level, on profit margins. If there is a mantra for market performance in the months ahead it might be simply this: Macro Matters.

Finding Joy in the Mediocre

The jobs report this morning was the last bit of monthly employment information the Fed will have to consider at the next Federal Open Market Committee (FOMC) meeting in the middle of the month. It was a mediocre result: economists expected to see 650,000 payroll additions and got 559,000 instead, with some modest growth in hourly wages. That’s just fine, as far as the market is concerned. A blowout ADP Employment Survey yesterday of 978,000 new jobs raised expectations that today’s BLS report might also surprise to the upside. That would immediately raise the specter of an overheating economy and bolster expectations of one of the dreaded t-words – tapering or tightening – happening sooner rather than later.

But a dismal underperformance of payrolls along this lines of last month’s 278,000 fizzle would also have been a wet blanket, fanning fears of a truly dysfunctional jobs market where help wanted signs go unfilled, restaurants desperately seek kitchen staff and everybody demands to be paid in cash (nudge nudge, wink wink). Nobody likes numbers that are really hard to explain in common-sense ways. So the actual outcome – a bit soft but not too soft – is a Candide-like best of all possible worlds for Mr. Market.

Your Prices and the Fed’s Prices (They Are Different)

Next up: inflation. The Consumer Price Index for May comes out next Thursday. The headline CPI is expected to increase by 4.6 percent on a year-on-year basis, with the core measure that excludes the volatile categories of food and energy due to rise by 3.4 percent. Both of those are comfortably the highest figures in more than a decade. While this report will come out in time for the Fed to digest it at the mid-month FOMC meeting, the CPI is not the Fed’s preferred gauge of inflation. That would be the core (again, excluding food and energy) Personal Consumption Expenditure (PCE) index, the next reading of which comes out on June 25.

For you – assuming you are a person who buys groceries every week and fills up the car with gas on a regular basis – that headline CPI number of 4.6 percent is much more relevant than the core PCE figure the mandarins in the Eccles Building will pore over during the FOMC meeting. Crude oil prices are up more than 40 percent since the beginning of this year. The UN Food and Agriculture Organization’s food price index is up more than 40 percent from its level one year ago. You are feeling the impact of this kind of inflation every time you go to the store. If you are a sharp consumer you may even be onto a little trick one of our colleagues here referred to the other day as “size-flation.” That’s when you seem to pay the same price for something as you are used to, but there is actually less of that “thing” in the box or bottle or what have you – 16 ounces when there used to be 20, or three quarters of a pound versus the old one pound standard. Keep your eyes open!

What Goes Around

The Fed has been serenely complacent about inflation for many months now, and it is extremely unlikely that Jay Powell will start complaining about cereal prices at the post-FOMC press conference in a couple weeks. Sooner or later, though, the inflation numbers that matter for you and me are going to matter to Powell and his colleagues as well. Prices flow through a value chain that starts with basic raw materials and other input costs, and end up as what we pay at the register. Companies at each stage of production and distribution have choices to make as to whether they can absorb price increases into their own profit & loss accounts or try to pass them onto the next stage of the chain.

When they absorb the costs it impacts profit margins – a figure analysts are keenly focused on during corporate earnings season. When they pass them on they run the risk of losing customers and market share. At some point it becomes clear that higher prices are having a meaningful economic impact. If it goes on for too long – if it looks to be a driving force in a longer economic cycle rather than a transitory phenomenon – then the Fed will have to act accordingly. The so-called “Fed put” – the assurance that the central bank can paper over any disruption in stock market prices with more easy money – will be far out of the money.

There are plenty of other variables swirling around this mix, more than we can cover in this brief commentary. Fear not, there will be much more to say about this in the weeks ahead. Macro matters.

Black Tuesday, 1929 turned out to be a big deal. Black Monday, 1987 – not so much. The history books all duly note that the Wall Street crash of October 29, 1929 marked the opening act of the Great Depression, during which the US stock market at one point in the early 1930s had lost 80 percent of its value from the 1929 peak. The market did not recoup all its losses from that ’29 high point until 1954.

Conversely the 1987 crash, dramatic as it was on that one single day on October 19, did not usher in anything other than a few weeks of higher-than-average volatility before the growth cycle of the mid-late 1980s resumed in full. Though in all fairness we should note that Black Monday ’87 did spawn a fairly well-received TV series on Showtime, a feat that so far has eluded the Crash of ’29.

With this in mind, folks paying attention to the market chatter this week may have heard the phrase “Black Wednesday” pass the lips of pundits who study the fossil fuels industry. To be perfectly honest, we are of the opinion that this trope of “Black X-day” itself, so beloved of Wall Street bards, is dated, stale and overdue for retirement. But we do agree that what happened this past Wednesday was significant enough that the day may wind up being one of those rare turning points identified by future historians.

Calling Engine No 1

So what happened on Wednesday? Within roughly a 24-hour period three major things took place in the world of Big Oil. At the annual shareholder meeting of ExxonMobil, the oil behemoth ceded at least two seats on its board of directors to a climate activist group called Engine No 1 (the group is expected to gain a third seat when the official vote count is completed sometime next week). To put it mildly, ExxonMobil’s management is not used to contested shareholder votes like this, particularly when the start-up activist group (Engine No 1 was founded just last year) was backed by some of the company’s largest institutional investors including BlackRock and Vanguard. The activist board members plan to be vocal in putting pressure on ExxonMobil to sharply reduce its oil output.

Something similar happened to Chevron at its general meeting on the same day: shareholders voted on a measure to set strict emissions targets from the products it sells. And while green-minded shareholders were finding their institutional voice here in the US, a perhaps even more far-reaching decision was handed down across the Atlantic. A Dutch court in The Hague, Netherlands, ruled that Royal Dutch Shell must reduce its carbon emissions by 45 percent by 2030 against its 2019 levels – on an absolute basis, which is stricter than the carbon intensity targets (amount of carbon per megajoule of energy sold) that the company prefers to use as its benchmarks. That’s not a suggestion – it’s a demand backed by law.

What’s the Market Impact?

Wednesday’s events didn’t reverberate in any kind of immediate panic selling by investors of energy shares. There was a bit of a midweek dip in Big Oil, but prices quickly stabilized. Indeed, the overall narrative for the energy sector so far in 2021 has been mostly positive. Fears of higher inflation, coupled with expectations of surging demand and supply shortages in key goods, have drawn investors to real assets like industrial and energy commodities. Energy is outperforming all other major S&P 500 industrial sectors in the year to date.

The sense among those who closely follow the energy industry is that the tangible effects of Wednesday will take some time to materialize, and in the meantime they are not quite ready to quit the sector while those positive short-term dynamics are still in play. But “short term” is the operative phrase here. In a bigger-picture sense one could argue that the market has already rendered its verdict on the future of Big Oil, well ahead of what happened this past Wednesday. The chart below shows the performance of the energy sector against the S&P 500 from the beginning of 2014 to the present.

Even with the sharp rally in energy shares that started late last year, the sector is worth only 60 percent of its value at the beginning of 2014, while the benchmark index has more than doubled in value. The longer-term question for the diversified energy majors like ExxonMobil and Royal Dutch Shell is whether this new level of direct pressure – from shareholders, from the courts and from general public opinion – will push them to more aggressively develop core competencies in clean energy sectors.

They will certainly face challenges if that is the route they choose – from agile clean energy companies already staking out real estate in the emergent sector to their own stale institutional cultures based on more than a century of assumptions about the primary role of fossil fuels in the economy. It’s not impossible. But at this juncture it would seem like a long shot. Wednesday May 26 could potentially be one of those narrative markers that actually stands the test of time.

There’s a lot of chatter out there about how the summer of 2021 is shaping up in equity markets. The bumpy-ride faction has enjoyed some validation recently, with volatility perking up after seeming to settle down at sub-20 levels on the VIX (kudos to whoever made that $40 million option bet a few weeks ago with a VIX-25 trigger). The sentiment that “volatility is back, baby” got some help from the plight of cryptocurrencies this week – yet another attestation, it would seem, to the rapid unwinding of those latterly high-flying speculative corners of the market.

Value Hits Pause, Again

What didn’t happen this week, though, while bitcoin and its ilk were flapping all over the place like injured cicadas falling off their trees, was another leg up for value stocks in their storied comeback against growth. The value rotation, of course, has been one of the big themes of 2021 thus far. As the chart below shows, though, it has not exactly been a seamless progression.

The big tailwind for value in the year so far was the sudden spike in interest rates back in late January, and the attendant rise in inflationary expectations. The sentiment benefitted key value sectors like financial institutions (higher rates = better net interest margins) and energy (real assets like commodities do well in inflationary environments). But that narrative sort of petered out in early April as rates started to stabilize and early signals pointed to a blowout earnings season (which signals have since been resoundingly confirmed). As the chart shows, growth’s gains narrowed the value rotation gap significantly. Who cares about those pesky valuations when earnings are set to top 30, maybe even 40 percent this year? Party on, Wayne!

Anything Goes

The gap widened again, though, as volatility retuned and actual inflation numbers started to come in. To be clear the Personal Consumption Expenditure (PCE) index (less food and energy), the Fed’s go-to inflation metric, is still below the central bank’s two percent target. But the Consumer Price Index, the inflation measure more familiar to Americans who don’t work at the Fed, jumped up to three percent (again, the core number that excludes food and energy) while producer prices, reflecting higher input costs for raw materials and transportation, notched a four percent increase.

Yet the trend seems to have stabilized once again. The really frothy end of the growth stock universe, where names like Tesla frolic and play, seems to have calmed down while the megacap leaders like Microsoft and Apple have come off their recent lows. On any given day, it seems, one thing may be up and the other down (yesterday it was growth, today value). Perhaps unsurprisingly, that dynamic adds up to a meandering market overall, rather than a discernable directional vector up or down. We’ve seen this dynamic before – meandering could foretell a relatively quiet summer where the market doesn’t do too much and the competing narratives moving value and growth more or less cancel each other out over time. But even a quiet spell can encounter those periodic pockets of turbulence, and we will not be surprised to see a few more of those along the way.