The Backdrop for 2H 2021:
- Better Economic Data – Economic data, which lags the stock market, hit rock-bottom last year, but we believe signs of a recovery have continued to appear, most notably with the recent Non-Farm Payroll and ISM data. Considering the fifth round of stimulus from Congress passed earlier this year, consistent declines in unemployment and the potential for an infrastructure bill, we believe sustained increases in consumer spending and job stabilization should be expected – both keys to the continued emergence from the pandemic-induced recession. Moreover, the consumer continues to sit on record amounts of cash.
- Better than Anticipated Earnings – After reaching nearly $165 on a trailing twelve-month basis for S&P 500 EPS at the end of 2019, the pandemic resulted in only a 15% drawdown in earnings – it is expected to only take 6 quarters to recoup the damages. We remain optimistic, as we continue to see the full-year 2021 estimates from Wall Street analysts continues to grind higher, now standing at $191, well above the 2019 level.
- Health of the Consumer – We believe the aggregate consumer is flush with cash, and once pent-up demand can safely be unleashed, the U.S. economy is set to rip higher. While we know that the cruel nature of the pandemic has had an adverse financial impact on many (particularly those less fortunate), in aggregate, the consumer coffers are presently funded. U.S. bank deposits are up more than $3 trillion from a year ago, while credit card balances are down 12% over the past year.
- Fed Tapering Misstep – Towards the end of Q2, the yield curve paused its steepening. Now, it is up the Fed Chair Jerome Powell to recognize the level of flattening. This means caution in communication if the Powell Fed is to avoid the mistakes of the Yellen Fed, namely inverting the yield curve and slowing the flow of liquidity to main street by redirecting said liquidity towards Wall Street. We believe that tapering could offset this flattening.
- Threat of the Delta Variant Causing Another Potential Shutdown – After a significant decline in COVID-19 cases in the U.S. earlier this year, variants of concern (VoCs) continue be a risk, as there have been strains, i.e., “P.1 Variant”, that are more contagious than the original strain.
- Possible Policy Errors Through Fiscal Tightening (Taxes) in 2022 – The lags associated with the long-term benefits of infrastructure spending are notoriously long and variable. Tax increases, on the other hand, tend to be retroactive and immediate. From a market perspective, the fear is that a fiscal drag sterilizes the positive impacts of reopening and already passed stimulus, leading to an economic environment more consistent with the period of secular stagnation after the GFC.
- Faster-than-Expected Inflation – The magnitude of the policy actions used to counteract deflation may, in the end, be hugely inflationary. Higher-than-expected inflation tends to be a major headwind to equity valuations. Right now, 5YR inflation breakeven figures are above the Fed’s 2% target. For markets, how the Fed chooses to address inflation is as important as the inflation itself.
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