Valued Clients and Friends,
The U.S. economy has surprised nearly everyone to the upside as it speeds along—thanks to re-openings and record stimulus. A path to normalcy has appeared with stadiums allowing full capacity, restaurants filling up, and summer vacations in full swing. The overall economic picture remains sound and will likely support strong profit growth going forward. But the pace of reopening also creates new hazards: supply chains are stressed, some labor shortages have emerged, inflation is heating up—at least temporarily—and asset prices look expensive compared to historical figures.
First-quarter earnings season is over, and results were strong. The percentage of S&P 500 companies beating earnings per share targets (87%) and upside to revenue growth (over 4 percentage points) were both the highest that earnings data aggregator FactSet has ever recorded. The U.S. economy has likely already recovered all its lost output from 2020, with U.S. gross domestic product (GDP) growing at roughly 6.5% in the second quarter of 2021 (source: Bloomberg). As it stands, this year is on pace to be the best year for GDP growth since the early 1980s, bolstered by fiscal and monetary stimulus.
Strong economic growth and massive stimulus has brought with it worries over the economy potentially overheating. The Consumer Price Index (CPI) for April sparked much of the concern, with the core reading (excluding volatile food and energy prices) rising 0.8% month over month, the highest since the early 1980s (U.S. Bureau of Labor Statistics). May and June inflation remained elevated, with CPI increasing 0.9% each month. Additionally, consumer prices are up 4.7% from February 2020 to June 2021, showing significant increases in prices from even pre-COVID levels. Problems filling jobs and supply chain issues are adding to the inflation pressures on top of pent-up demand as the economy fully reopens.
Although these concerns are real, longer-term inflation should come back to trend. Technology, globalization, the “Amazon effect”, increased productivity and efficiency, automation, and high debt (which puts downward pressure on inflation) are among the major structural forces that have put a lid on inflation the past decade plus—and will likely continue to do so.
The Federal Reserve remains patient, stating they will allow inflation to run hot for a period before considering raising interest rates. Per the Fed Chairman, the Federal Reserve does not anticipate increasing interest rates until 2023 – but should inflation continue to run hot for some time, an interest rate hike may be nearer than projected. Importantly, the Federal Reserve seems cautious to step in front of the economic recovery and wishes to see the economy firmly back on its own feet before intervening.
While the market has had strong performance since the COVID lows of March 2020, there is the potential of volatility in the summer months as the effects of the stimulus begin to fade. Many of the leading economic indicators, including retail sales, wage growth, truck shipments, and the yield curve, all point towards the US economy being in a healthy expansionary period. As such, we would anticipate any coming volatility in the markets to be relatively modest.
Alternative assets, such as real estate, commodities, and private equity/credit, will be increasingly important in portfolios going forward as diversifiers, strong growth tools, and income-generators. We continue to monitor various alternative asset classes and look to add them to portfolios where appropriate.
Overall, the foundation has been laid for a healthy economy in the coming years. We continue to monitor economic indicators with great care – and will constantly adjust portfolios to take advantage of opportunities that arise in the markets.
We hope each of you enjoy these summer months! Please reach out should you have any questions – we are happy to help.
Gallacher Investment Committee