As of August 17, 2021
In July, the S&P 500® Index ended its sixth month in a row with gains. According to Bespoke Investment Group, historically, the S&P 500 has gone on to post a seventh month of gains 68% of the time. Over the subsequent six months, the index goes on to post an average gain of +6.3% and is positive 71% of the time. The point? Strength generally begets more strength.
Easy monetary conditions, strong consumer finances, pent-up demand, a strong economic backdrop and earnings’ outperformance point to a bullish environment conducive to higher stock prices. However, one significant pushback from the bears remains: What happens when growth starts to decelerate?
Though we expect solid economic/profit growth for a number of quarters, more sanguine investors are asking how much future growth is already priced into stocks today. Particularly against the highly transmissible Delta coronavirus variant, which could slow reopening momentum.
It is important to note, while growth is likely to decelerate over the coming quarters, the solid fundamental backdrop is supportive for higher asset prices, in our view. And given the outsized economic growth we are still likely to see in the second half of the year, combined with strong profit trends, U.S. stock valuations appear reasonable, in our view.
With stocks sitting near all-time highs at the moment, here are a few factors investors should consider.
- Inflation. Inflation pressures should moderate over time. However, we believe the critical question is how much more or less compared to market expectations. At present, several forward-looking bond proxies forecast inflation growth to come down over the next several quarters. And even looking out into next year, year-over-year rates of change in inflation should look much less aggressive. We believe the pace of price increases across several goods, services and commodities are very likely to slow over the next few quarters, as pent-up demand is satisfied and global supply chains normalize. Notably, this should allow the Federal Reserve to maintain its accommodative monetary policies, which could provide a tailwind for stock prices. That said, inflation pressures may not decline as fast as the market expects, which could create a period of volatility for stocks.
- COVID-19. Evolving COVID-19 dynamics are currently weighing on stock performance in areas tied to the reopening trade. U.S. small-caps and the Energy, Financials and Industrials sectors have underperformed the broader market more recently. However, second quarter earnings growth was far more robust than expected across these areas. Notably, many businesses in industries tied to the reopening theme have said on their earnings calls that current COVID-19 trends have had little to no impact on consumer/business demand thus far. Nevertheless, while it is unlikely the Delta variant will create the type of economic disruption seen last year, reopening momentum in the United States and abroad could slow — particularly if states, local governments and businesses reinstate more aggressive restrictions.
- China. Beijing’s growing regulatory clampdown on private industries and sectors within China's economy has created elevated uncertainty for foreign investors. Publicly traded Chinese companies tied to areas like private education, ridesharing and technology, as examples, have seen their stocks decline significantly due to the government’s increased regulatory efforts. The growing uncertainty and severe threat to shareholder rights from China’s actions have weighed on emerging markets more broadly, as China represents over 30% of the MSCI Emerging Markets Index. As a result, continued volatility on the China regulatory front could continue to impact emerging markets and international investments.
- Market volatility. The S&P 500 Index has not experienced a 10% or more correction this year. In our view, temporary drawdowns (drops) are a healthy and regular occurrence in the stock market each year. If one were to occur over the next few months and economic/corporate conditions remain essentially unchanged, we would consider the dislocation a buying opportunity for long-term investors.
Although regulatory activity in China, inflation pressures, and the potential for a market correction are risks for investors, we believe the economic and business environment is strong and supportive for stocks. In our view, well-diversified investors should choose stocks over bonds, favor cyclical value in the U.S. and Europe and focus on high-quality investments.
Data source for indices and sector graphs: Morningstar Direct, as of August 9, 2021.
Past performance is not a guarantee of future results.