Significant support for stocks remains in place despite concerns about the resurgent virus.
The economic data continues to show a strong expansion is underway, corporate profits are very healthy and exceeding high expectations, while the Federal Reserve remains committed to a very accommodative monetary policy.
Healthy Economic Readings
The Conference Board’s Consumer Confidence Index rose again in July and is now just below its level in February 2020, when the pandemic-induced recession started. Confidence is up at the fastest year/year pace since January 1984. Both the index level and its year/year momentum are consistent with above-trend economic growth. It suggests a continued robust expansion, although the pace will likely moderate in the second half of 2021, as implied by other economic indicators and the winding down of fiscal stimulus.
The Present Situation Index edged up to its highest level since March 2020. Notably, current job availability was the highest since July 2000, and the second highest on record. This is another data point that suggests strong job growth in the coming months that supports economic growth.
Second-quarter economic growth came in at a 6.5% annual rate, the fastest pace since the third quarter of 2003, excluding the pandemic rebound, but short of the consensus of 8.5%. The increase was led by consumer spending and capital spending growth, as the economy continued to reopen amid more vaccinations. But housing, inventory investment, and net exports subtracted from growth, as bottlenecks and supply chain issues persisted. Government spending was also a drag, as fiscal stimulus waned.
Nevertheless, economic output last quarter surpassed its pre-recession peak by 0.8%, so the output recovery is now complete. Importantly, the much stronger-than-expected consumer spending and solid capital spending signal a successful handoff from public sector stimulus to private sector growth—important for a sustainable economic expansion.
Business surveys continue to show booming manufacturing conditions. July PMI data from IHS Markit signaled the most substantial improvement in operating conditions across the U.S. manufacturing sector on record. Overall growth was supported by stronger expansions in output and new orders, with the latter increasing at the second-fastest pace since data collection began in May 2007.
Unprecedented supplier shortages and delays continued to exert inflation pressures and stymie firms' ability to process incoming new work. With record-low customer inventory levels, manufacturing conditions should remain strong, at least through year-end. We also expect inflation pressures to abate once supply (production) catches up to demand (new orders).
Outstanding Corporate Profits
Last week was the busiest week for second-quarter earnings reports, which continue to exceed high expectations. At the beginning of earnings season, profits were expected to grow at about 62%. With about 76% of the S&P 500 Index market capitalization having reported so far, expectations are now for stellar earnings growth of about 83%.
We continue to see a strong rebound in profitability for the highly cyclical sectors that were most impacted by the pandemic shutdown. The significant rebound in corporate profitability is a critical support for stocks. This is the last major week for second-quarter earnings with results coming from 142 companies.
Accommodative Monetary Policy
At last week’s Federal Open Market Committee meeting, the Federal Reserve held steady its target for overnight rates to a range of 0-0.25% and will continue buying bonds at the current $120 billion/month pace ($80 billion in U.S. Treasuries and $40 billion in mortgage backed securities). There was no sign of tapering these purchases in the text of their release.
At the press conference following the meeting, Fed Chairman Powell downplayed inflation concerns and reiterated that he sees no reason to raise interest rates any time soon. This highly accommodative monetary policy remains a key support for stocks and other risk assets.
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