As of July 20, 2021
With the third quarter of the year underway, major U.S. stock averages sit near all-time highs. And bond yields have moved lower on peak growth concerns, lingering pandemic issues and expectations that inflation pressures could moderate with time.
Importantly, COVID-19 dynamics have improved across much of the western world this year, as vaccines have become more readily available.
Through the first six months of 2021, cyclical stocks led markets higher, and reopening momentum carried most major equity averages higher across the globe.
But more recently, momentum has shifted back to growth areas, like the Information Technology sector. Concerns about peak growth have given stocks with strong long-term profit drivers a boost, given their ability to grow profits in multiple economic conditions.
The table below outlines our assessment of the bull and bear case for stocks at the start of the second half. We believe that monetary and fiscal conditions should remain a tailwind for asset prices throughout the year. Investors should skew to a bullish outlook, in our view, given the low interest rate environment and strengthening economic/corporate earnings trends expected to continue through the year (especially in sectors of the economy most depressed by the pandemic).
In addition to the bull and bear case outlined above, here are three big-picture market themes for investors to consider this quarter:
- Expect huge Q2 corporate profit numbers, but stocks have already priced in the eye-popping surge. In our view, given the already elevated expectations, stock prices could react more to second quarter earnings reports (starting this month) that help color the outlook for growth through the rest of the year. For instance, analysts expect S&P 500® Index earnings per share (EPS) to grow by +64% year over year in Q2. While aggressive Q2 corporate profit beats could help drive stock prices higher through the earnings season, we believe investors will be far more focused on corporate insight regarding supply disruptions, labor shortages, profit margins and inflation impacts. As a result, corporate commentary and outlooks that address these issues may have a more meaningful impact on stock prices through the front half of Q3.
- Inflation will remain a hot-button topic throughout the quarter. Investors have a good handle on inflation impacts from year-over-year comparisons and reopening momentum. However, it may become more evident over the third quarter how temporary or enduring inflation becomes. The Federal Reserve and a number of economists believe inflation pressures should moderate in the back half of the year and into next year. On the other hand, we believe data that shows inflation pressures rising or remaining at elevated levels could quickly become a headwind for stock prices.
- The Federal Reserve and potential policy shifts could stir market volatility in late summer. Investors are unofficially targeting the Fed’s Jackson Hole Economic Symposium in late August as the launch point for more details about the central bank’s bond-tapering strategy. While we believe it’s unlikely the Fed will begin to reduce its $120 billion-a-month in government/agency bond purchases until next year, the setup for communicating its approach will likely be transparent and proactive. Though we believe Fed policy will remain ultra-accommodative for the foreseeable future, a wildcard for investors is how stock prices react to the idea of slightly tighter financial conditions moving forward.
Notably, stocks are not cheap today given the elevated valuations. Considering the lingering pandemic issues around employment and global supply chains, combined with a still-undetermined path for where inflation pressures ultimately land, investors should take a pragmatic view of market opportunities in the second half.
While stocks have a lot to live up to, the world is reopening and returning to normal business activities. Consumers and businesses are able and willing to spend, which should drive corporate profits in the second half. Overall, we believe the setup for stock prices remains solid.
Data source for indices and sector graphs: Morningstar Direct, as of July 12, 2021.
Past performance is not a guarantee of future results.