July 19, 2021
Thanks to unprecedented fiscal and monetary stimulus, along with a successful vaccination program, the U.S. economy is humming and corporate profits are surging. However, second quarter likely marks the peak in economic and profit growth; but the cycle has a good chance to become self-sustaining, providing durable growth even as stimulus is ultimately paired back.
Meanwhile, inflation is rising – albeit mostly temporary due to supply constraints at a time of reopening, pent up demand and massive stimulus – but should begin to ease this fall; watching wages and rents. Jay Powell this past week appeared to temper the hawkish takeaway from last month’s Federal Open Market Committee (FOMC) meeting by saying they are a “long ways off” from tapering. The risk is that the longer inflation runs hot, the more imbedded it becomes in expectations. Falling bond yields in this context are perplexing, suggesting either the market believes Powell that inflation is indeed “transitory” or central bank purchases are simply overwhelming.
Covid cases are beginning to rise again due to the Delta variant, but given high (and rising) rates of inoculation should be contained and not a major threat to the healthcare system or the U.S. economy.
The market continues to be supported by rising S&P profits, low bond yields, and an accommodative Federal Reserve (“Fed”); but high stock valuations and sentiment, along with deteriorating market breadth and seasonality, could lead to near-term volatility. The risk include 1) margin pressure caused by rising input costs, 2) inflationary wage-price spiral forces the Fed to act sooner, more forcefully than expected, 3) regulatory or legislative attacks on “Big Tech” gain traction, 4) infrastructure bill gets scuttled by politics, 5) the global economy continues to be restrained by Covid.
July 5, 2021
The U.S. economy is firing on all cylinders. Retail sales, industrial production, housing, autos, travel, dining and entertainment, are all helping to drive surging real GDP and corporate profits. Inflationary pressures, however, are real – albeit mostly temporary caused by supply constraints at a time of reopening, pent up demand, and massive stimulus – and should hopefully begin to ease this fall as those factors recede. The risk is that the longer it goes on, the more embedded it becomes in expectations, which would make it that much more difficult for the Federal Reserve to stamp out.
The Federal Reserve took its first small steps towards preventing an overheating economy by signaling rising hawkishness at its most recent FOMC meeting, but in doing so it also raised some uncertainty around monetary policy, which will likely serve as an offset to rising earnings estimates, keeping stocks within a narrow but choppy range in the near-term.
The door seems to be open for a bipartisan deal on a smaller infrastructure bill without tax hikes if President Biden opts to seize it, potentially at the expense of upsetting the progressives in his party without line-of-sight to a bigger tax and spend social welfare agenda.
While rising debt and deficits remain a longer-term threat to growth and prosperity, bull markets typically don’t end until the economy overheats, the Federal Reserve overtightens, the yield curve inverts, and profits decline. This bull market continues to be supported by rising profits, low bond yields, and for now a supportive Federal Reserve. Risks include: 1) rising input costs leading to margin pressures, 2) an inflationary wage-price spiral develops, forcing the Federal Reserve to act sooner and more forcefully than expected, 3) growing regulatory or legislative attacks on Big Tech gain traction, 4) a rising threat of higher taxes to restore fiscal sanity, and 5) other unforeseen exogenous shocks.
June 7, 2021
For all practical purposes, the Pandemic is over in the U.S., fueling re-openings and a continued march towards normalcy. Consumers have ample dry spending powder, along with rising household net worth, supporting near-term economic and profit growth expectations. CEOs are highly confident, bolstering the outlook for hiring and investment.
However, there is also evidence of inflation everywhere, fueled by supply constraints. The question is how much of this is transitory – the market will likely remain on edge until that is determined. Supply constraints also serve as a near-term regulator on the economy, limiting its potential at a time of rising prices – risking a “stagflation-lite” environment.
With $5 trillion in fiscal stimulus and $9 trillion in combined Federal Reserve and European Central Bank balance sheet expansion in the past year, the bulk of the stimulus is behind us. Peak stimulus means peak growth. It appears that the Biden administration will be forced to downsize its tax and spend ambitions; we expect smaller package(s) passed through reconciliation, but also smaller tax hikes.
The bull market is not over, but it could be difficult for the market to make material headway near term so long as fears exist that runaway inflation may force the Federal Reserve’s hand (the Federal Reserve is now “talking about talking about tapering”). Full valuations, elevated investor complacency and rising bond yields probably mean choppy market conditions.
We continue to monitor potential risks; such as an inflation scare causing a “disorderly” rise in bond yields, a change in the Federal Reserve’s policy, the threat of higher taxes, and any other unforeseen exogenous shock.
May 10, 2021
First quarter profits have significantly exceeded expectations and macro economic data continues to be strong despite the latest jobs report, which came in well below expectations. On the Covid front, the Johnson & Johnson pause resulted in a moderation in the vaccination rate, but Covid appears to be under control here in the U.S. While progress in Europe is positive, more still needs to be done in the emerging market countries to slow the spread. March stimulus checks significantly boosted savings – providing lots of fuel as the economy reopens. Supply constraints continue to fuel inflationary pressures, with questions about the ability to pass through prices to consumers. Supply constraints may also serve as a temporary “speed limit” on the economy, limiting its potential at a time of rising prices. The Biden administration is “going BIG” on proposed deficit spending, but with narrow margins in Congress we expect smaller spending package(s) and more limited tax hikes. This should still be expansionary, especially in the early years. The weak jobs report provides backing for the Federal Reserve’s patient approach. Bond yields have taken a breather – the real yield is back down to -.9%. We see stock valuations as full and investor complacency as elevated – preconditions for increased market volatility in the weeks and months ahead. Risks continue to be an unexpected vaccination snafu or a troublesome new Covid variant, an inflation scare that causes a “disorderly” rise in bond yields, changes in Federal Reserve policy stance, and rising taxes. However, we remain broadly constructive on the market on the basis of highly accommodative monetary policy, massive fiscal stimulus, increasing vaccinations and rising S&P profit estimates.
April 26, 2021
Macroeconomic data continue to show a post-winter storm rebound. While Covid increasingly appears to be under control here in the U.S., India has driven global cases to new highs. The combination of pent-up demand, stimulus checks, and increasing vaccinations is contributing to economic boom-like conditions. We continue to monitor mounting inflationary pressures and will be focusing on those companies that have pricing power to protect or sustain profit margins. The Biden administration is “going BIG” with deficit spending, seemingly attempting to accomplish all of its policy objectives at once. Meanwhile, we expect the Federal Reserve to continue to maintain its highly accommodative monetary policy for the time being. We are testing limits of how far we can go with massive deficits, debt and central bank balance sheet expansion with uncertain longer-term consequences. We are now roughly one third of the way through earnings season and so far both the rate and magnitude of earnings beats have surprised to the upside, driving further upward revisions to S&P 500 earnings estimates. Bond yields, meanwhile, have taken a breather, providing highly-valued growth stocks (and home buyers) a reprieve for now. We see stock valuations as full and investor complacency as elevated – preconditions for increased market volatility in the weeks and months ahead. Risks continue to be an unexpected vaccination snafu or a troublesome new Covid variant, an inflation scare that causes a “disorderly” rise in bond yields, changes in Federal Reserve policy stance, and rising taxes. However, we remain broadly constructive on the market on the basis of highly accommodative monetary policy, massive fiscal stimulus, increasing vaccinations and rising S&P profit estimates.