As often happens near the end of a quarter, in the past week, PLANADVISER Magazine has received an extensive amount of macroeconomic commentary, both looking back over what has happened in the markets and prognosticating about what may come next.
In the view of Brad McMillan, managing principal and chief investment officer (CIO) at Commonwealth Financial Network, the U.S. and global economies are on a “long and winding road” toward true recovery.
“The story of 2020 was just how far from normal we could get,” he suggests. “We faced a pandemic with millions of cases and hundreds of thousands dead. Fear and government policy shut down the economy, keeping people at home and destroying businesses. Millions of people lost their jobs. From a certain perspective, it looked like a depression in the making. And it could have been. Fortunately, a combination of government stimulus programs and rapid vaccine development helped us survive economically and start to control the virus.”
McMillan says the initial recovery experienced in the early parts of 2021 has created some new problems to grapple with: those of success.
“Labor and supply shortages, plus the shadow of inflation, are calling the recovery into question,” McMillan says. “The initial bounce back has been strong, but will we get back to normal by year-end? Based on what we know today, the answer is yes.”
Of course, medical risks remain, but the coronavirus’ ability to cripple the economy looks to be played out, McMillan says, especially at a national level.
“At the moment, there is a disconnect between jobs and workers,” he adds. “Still, the workers are there, and those jobs will be filled. Supply chains also have some gaps, creating shortages and high prices. At the same time, suppliers are working hard to fill those gaps, and in some areas (lumber and copper, notably), supplies are already up and prices down. And, with the labor market and business supply chains normalizing, inflation should pull back by year-end. … Risks remain, of course. The Delta variant of the virus could lead to local outbreaks in areas with low vaccination rates. Even if that happens, though, a national outbreak looks unlikely. Further, the risk is dropping by the day as more people get vaccinated.”
Beyond “healthy and improving fundamentals,” other tailwinds should keep the economy and markets moving, he notes.
“On the fiscal side, more governmental stimulus in the form of infrastructure spending is likely to start by year-end,” McMillan says. “This spending is sure to help growth. On the monetary side, the Federal Reserve has committed to keeping interest rates low at least through the end of 2021. Rather than slowing things down, the government will keep pushing the economy forward.”
The outlook provided by LPL Financial—put together by Ryan Detrick, chief market strategist, and Jeff Buchbinder, equity strategist—agrees that the U.S. and global equity markets had strong starts this year, with the S&P 500 index up about 14% so far. However, Detrick and Buchbinder share some concerns that most of those gains came early in the year, and many stocks have stagnated over recent months.
“The good news is the second year of every single bull market since World War II has seen the S&P 500 climb higher,” the pair explains. “That is 12 for 12 for year two gains. The second year for this bull market started on March 23, 2021, and so far, stocks are off to a solid start—up more than 9%. The bad news is for many of the past bull markets, year-two gains were quite muted, as stocks caught their breath from the year-one sprint. With the S&P 500 up so substantially from the March 2020 lows, we wouldn’t be surprised at all if history repeated and stocks saw choppier action in year two.”
The pair is also tracking the potentially worrying dynamic of performance consolidation.
“The S&P 500 index hit a new record high last week, but under the surface fewer stocks have been participating,” they note. “Just 15% of the stocks in the index hit a new one-month high along with the benchmark on June 24, and, for the first time since December 1999, a record closing high occurred with less than half of the stocks in the index above their 50-day moving averages. If the last few years have taught us anything, it should be that the largest technology stocks are capable of powering the S&P 500 to new highs. However, a far healthier and more sustainable trend typically sees stronger participation, like earlier in the year when new highs in the S&P 500 were commonly accompanied by 30% to 40% of the index hitting new highs as well.”
To be fair, the pair emphasizes, some of this dynamic is due to “rotation under the surface.” This is to say, as interest rates have pulled back recently, value-oriented sectors such as materials, financials and industrials have underperformed and outright declined over the past month.
“Meanwhile, growth stocks have gained more than 6% in that time, boosted by outperformance from some of the most heavily weighted names in the S&P 500,” Detrick and Buchbinder say. “And though this rotation can help to mute declines in the broad benchmarks, it may also serve to limit upside potential. As the old saying goes, ‘play the averages, get average returns.’”
Though they discuss some potentially worrying signs about higher-than-typical stock valuations, the LPL strategists also come down on the side of optimism.
“While stock valuations look expensive, which could introduce above-average downside risk, they look quite reasonable when low interest rates are factored in,” they conclude. “Additional volatility, weaker participation and high valuations might sound scary, but we believe that any weakness would likely be a buying opportunity, as the economic and earnings environments remain exceptionally strong as we head into the second half of 2021.”
Rupert Thompson, CIO at Kingswood, observes that, despite June historically being the weakest month of the year, equities have resumed their upward course after a pause in May. He says the continuing gains can really be put down to two factors: liquidity and earnings.
“Liquidity conditions remain very supportive,” Thompson says. “Following the debate over the recent Federal Reserve move to start forecasting two rate hikes in 2023 rather than none, Fed officials last week were at pains to point out that this did not herald a major policy shift. Indeed, QE [quantitative easing] tapering remains on course to start early next year and the Fed still very much believes the bulk of the surge in inflation is temporary. … The rise in core inflation has also been concentrated just in a few areas, such as used cars, which are subject to particular distortions and shortages. Strip out these outliers and core inflation is running at only 1.7%. All the same, inflation worries look set to continue over the coming months, with oil prices doing nothing to ease such concerns.”
On the earnings front, in Thompson’s view, the key point to remember is that the market’s gains over the past year have “merely kept pace with earnings.” That is, global equity prices are up 40% since last June, but so are forward-looking estimates for earnings. Valuations have, in fact, declined a little over this period, Thompson observes, and confidence in the outlook for U.S. growth has also been given a boost by news that a provisional bipartisan agreement has been reached on a sizable infrastructure spending package.