In this article we review:
- What we believe to be the market catalysts for the remainder of 2021 and beyond
- Newer market concerns recently receiving increasing focus
- Netting out these catalysts and concerns to determine market opportunities
Investors begin the second quarter of 2021 facing a far different market landscape than was the case when the year started. While various market worries have subsided in recent months, others have emerged, and with stocks reaching record highs and credit spreads back below pre-pandemic levels, we believe now is a crucial time to identify market catalysts and concerns and net out the opportunities when taking both into account.
We view the following to be current and meaningful market catalysts as we look to the remainder of 2021 and beyond.
The U.S. economy is poised to grow much stronger than previously anticipated. We believe U.S. gross domestic product (GDP) could eclipse 7% annualized growth for CY 2021 following a strong first quarter and as vaccines continue to achieve wider and faster distribution. We also believe aggregate real GDP could exceed pre-pandemic levels by the end of the year, confirming a V-Shaped recovery.
Corporate earnings also appear positioned to surpass pre-virus levels by the end of 2021. S&P 500® operating earnings is now estimated to come in north of 25% annual growth for CY 2021 (FactSet Earnings Insight), which, if accomplished, would exceed the pre-pandemic earnings of 2019 by more than 10%.
Fiscal stimulus has come up big. With last month’s congressional passage of President Biden’s $1.9 trillion COVID-19 relief and stimulus package (American Rescue Plan), more than $5 trillion of stimulus has begun, or will soon begin, being disseminated into the economy. This should also provide a tailwind to the economy over the next year.
We see the Federal Reserve remaining accommodative for the foreseeable future. Even as the economy improves and inflation potentially moves toward its long-term target, we believe the Fed will hold the Fed Funds rate within its current target of 0–0.25% into 2023 and maintain open market activity of $120 billion per month for the remainder of the year. One major criterion for doing so, in our opinion, is Chairman Powell’s commitment to avoid any policy tightening until, in his words, “substantial further progress has been reached.” We believe this will pertain to the more than 10 million net job losses remaining from the depths of last year’s depressed environment.
However, markets rarely accept favorable developments without incorporating some degree of additional angst, and these past few months are no exception. Thus, newly minted market concerns, until recently flying below the radar include:
After a long absence, the prospect of higher inflation has entered the fray. With the economy making enormous strides since last year’s depressed levels of demand, it is now likely we could see inflation rise above the Federal Reserve’s long-term target of 2% at some point in the upcoming year. However, at the current time, we believe rising inflation will likely be transient in nature and not sustained or warranting Fed policy action.
We believe longer-term interest could continue to rise. While the move in the 10-year Treasury rate from its record low 0.52% last August to more than 1.70% has likely contained some reaction to potential inflation, we believe this ascent for the most part reflects dramatically improving economic conditions in the months ahead. We see the 10-year Treasury yield potentially exceeding 2% by the end of 2021 and believe a steepening yield curve will prove advantageous for the financial sector.
A major political battle awaits regarding President Biden’s announced $2.3 trillion infrastructure spending plan and the tax increases proposed to pay for it. Likely to be more controversial than the spending bill itself will be an overhaul of the federal tax code as the financing vehicle to pay for it. On the table will be increases in the marginal corporate tax rate and top bracket rates for individuals, higher capital gains rates at certain thresholds, applying an additional payroll tax for higher-compensated employees, reducing the exemption on estate tax, and eliminating the capital gains step-up provision on inherited assets. These potential tax increases could create negative market reaction if they are ultimately passed as proposed. Expect a fierce fight between the parties on this legislation as it is unlikely tax increases will garner any political support from Republicans in the House or Senate.
Given the strong move in the markets over the past year, we believe the risk of a short-term market correction remains high. History infers that stock price corrections of 10% or more in the S&P 500 occur about once every year-and-a-half, and with better than 80% total return in this index since March of last year, investors may want to brace for such an event. That said, under the current market environment, if downside volatility of this nature were to transpire, we would likely view it as a strong buying opportunity.
In netting out the above catalysts and concerns, we believe the overall benefits of a higher growth environment outweigh the market challenges created by it. Therefore, specific opportunities might include:
We continue to see long-term opportunities in stocks. We believe equity valuations remain reasonable as measured by expected earnings yields in comparison to still historically low, longer-term interest rates. In addition, we are entering an environment where aggregate GDP and corporate earnings will soon fully recover from their recessionary lows of last year, likely soon reaching record highs for both and doing so alongside a highly accommodative Fed in terms of short-term rates and open market activity. The last time this happened was during 2011–2014, and stocks performed exceptionally well in those years.
We see a meaningful change in leadership from growth to value stocks continuing in the year ahead. Following a decade in which growth stocks have materially outperformed their value counterparts, we see a change in the market’s preference between the two as being a favorable and healthy signal. This is likely to be driven by the rising tide of an improving economy, a steepening yield curve, and the ultimate re-opening of U.S. businesses potentially changing consumer behavior in a manner more favorable for the value universe.
We are increasing our year-end 2021 price target on the S&P 500 to 4,500 from our previous target of 4,200 when the year began. Reasons for this upward projection include higher expected corporate earnings, stronger economic growth, continued accommodative monetary policy from the Fed, the impacts of fiscal stimulus, and the potential success of wider vaccine distribution in reversing virus trends and further reinvigorating consumer activity.
Bond investors should consider staying short on the curve with a strong credit focus. Given the recent rise of long-term interest rates and the tightening of credit spreads to pre-pandemic levels, we believe bond investors should consider remaining below benchmark durations as the yield curve potentially steepens further and excess returns above current coupon rates could prove challenging. Bond investors may also want to consider seeking active managers capable of identifying individual credit opportunities not found in passive benchmarks.
In summary, we believe investors have more working for them than against them in the current environment, and when all is said and done, the benefits of higher growth should outweigh the ancillary challenges created in the process. Nonetheless, markets have clearly shifted a good bit of attention in recent months toward a new set of criteria. While this may feel disruptive at times, we ultimately view such changes in focus as healthy signs of longer-term opportunities.
Investments are subject to market risk, including the loss of principal. Asset classes or investment strategies described may not be suitable for all investors.
Past performance does not guarantee future results.
Equities are subject to market risk meaning that stock prices in general may decline over short or extended periods of time.
Fixed income investing is subject to credit rate risk, interest rate risk, and inflation risk. Credit risk is the risk that the issuer of a bond won’t meet their payments. Inflation risk is the risk that inflation could outpace a bond’s interest income. Interest rate risk is the risk that fluctuations in interest rates will affect the price of a bond. Investing in floating rate loans may be subject to greater volatility and increased risks.
Growth stocks typically are particularly sensitive to market movements and may involve larger price swings because their market prices tend to reflect future expectations. Growth stocks as a group may be out of favor and underperform the overall equity market for a long period of time, for example, while the market favors “value” stocks.
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