As of May 18, 2021
As many parts of the world continue to reopen more fully, life across the globe is slowly returning to normal. The United States, Asia and parts of Europe all have been seeing a resurgence in activity.
In many ways, the U.S. is leading the way. More than half of the U.S. adult population has received at least one dose of a COVID-19 vaccine. During the first three months of the year, U.S. GDP grew by a historically strong +6.4% while S&P 500 company profits rose by roughly +49% on a year-over-year basis. With most of the first quarter reporting season now complete, it’s safe to say S&P 500® Index companies saw their best quarter of profit growth in more than 10 years. The profit boom has prompted analysts to raise their second quarter earnings estimates at one of the fastest rates in almost 20 years.
In aggregate, S&P 500 companies have exceeded first quarter profit expectations by an astounding +22% — the second-highest level on record. The extraordinary corporate profit results last quarter were driven by outsized estimate cuts during the pandemic, massive fiscal/monetary stimulus and a strengthening economic recovery across the U.S.
U.S. economic activity is booming. Notably, job growth continues to strengthen, despite tight labor market conditions and weaker-than-expected job growth in April. Manufacturing and services activity across the U.S. sits at or near record highs. High-frequency measures, including OpenTable dining reservations and TSA throughput, show more of the country is returning to regular activity.
In China and other parts of Asia, manufacturing and services activity also sits near record highs. And in Europe, an improved vaccine rollout, as well as reduced coronavirus restrictions, could see economic trends improve over the second quarter.
Overall, conditions continue to strengthen in economically significant areas of the world, helping to lead global stocks higher. Central bank liquidity, supportive retail mutual fund inflows, a pickup in share buybacks and a pullback in interest rates are other bullish factors contributing to S&P 500 all-time highs.
Unfortunately, supply constraints (e.g., semiconductor shortages, longer lead times, tight inventories) could weigh on companies’ ability to meet surging demand in the second quarter. Broader worker shortages due to lingering pandemic effects could also weigh on employers’ ability to staff up for specific industries. Corporate America most often cited on their first quarter conference calls that meeting the pent-up demand and higher input/inflation pressures were their most significant challenges to growth in Q2.
Looking ahead, we recommend investors consider the following market themes shaping stock prices:
- U.S. markets have largely priced in a “peak everything” environment. This is a macro backdrop where, on a year-over-year basis, economic activity and profit growth are likely to top out during the next few months.
- We believe stocks are well supported by strengthening fundamentals such as revenues and earnings and could gravitate higher if conditions continue to brighten. And though growth in the U.S. may peak in the second quarter, economic and corporate fundamentals should remain strong throughout the year. Historically, that’s a positive environment for asset prices longer term.
- While it may be tempting in such a positive environment, ignore the simple market adage of “sell in May and go away” and continue to review your portfolio regularly. Stock returns are historically less robust in the May through October period, but they are generally positive.
- Inflation pressures, supply disruptions and worker shortages could weigh on companies’ ability to meet surging demand in the second quarter. But for now, investors should consider these issues temporary speed bumps in the ongoing recovery.
- Importantly, the possibility of higher corporate and individual taxes next year is growing due to policy proposals from Washington. But alone, higher taxes would be unlikely to disrupt market momentum longer term, in our view.
Outsized profit growth, monetary/fiscal tailwinds, low interest rates and greater COVID-19 vaccine availability (and uptake) should help keep economic activity bright this year. But investors should not ignore the elevated stock valuations, fully priced assumptions for growth and inflation pressures that could linger longer than most expect.
Overall, we believe the bullish narrative should continue to win and push stock prices higher through the rest of the first half of the year. And while we believe the second half of the year could continue to line up well for equity investors, we suspect some of the concerns we’ve outlined could prompt more attention as the year comes to a close.
Data source for indices and sector graphs: Morningstar Direct, as of May 10, 2021.
Past performance is not a guarantee of future results.