July 6, 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.