Stocks had another positive week, with the S&P 500 Index advancing 0.6% and leadership remaining with cyclical sectors.

The incoming economic readings remain historically strong, which supports an outlook for very strong profit growth, especially within sectors that are major beneficiaries of the reopening. Industrials (73%), Materials (60%), and Financials (48%) are all reopening beneficiaries that are expected to see profit growth better than the overall market’s 34% in 2021, according to the Institutional Brokers’ Estimate System (IBES). The Energy sector is another reopening beneficiary that continues to see its earnings estimates move higher.

U.S. Economic Readings Remain Historically Strong

The ISM Services PMI (a timely business survey) rose more than expected to a fresh record high in May, as the reopening of the economy translated into faster services activity growth. Both business activity and new order growth picked up last month, while export orders grew at the fastest pace since October 2018, as demand strengthened. With more firms reporting difficulty finding skilled labor, employment growth moderated.

Firms also continued to struggle with supply shortages, as deliveries slowed further and backlogs accumulated at a record rate. Inventory sentiment plunged to a new record low, as more managers thought their inventories were too low. This is a reflection of the current shortages, but also suggests potentially strong future demand as firms rebuild their stocks. With widespread shortages, pricing pressure remains a concern. However, we continue to expect these inflationary pressures to be transient and to subside as supply chains get fixed (we are already seeing signs of this).

Confirming the strength of the ISM survey, the Markit Services PMI for May also reached a record high. Firms attributed the improvement in demand to higher business and consumer confidence, due to the successful vaccination campaign and the reopening of the economy.

Coupled with historically high manufacturing surveys, these surveys are consistent with well above-trend economic growth. Indeed, the Atlanta Federal Reserve GDPNow estimate for second-quarter economic growth now stands at a very impressive 10.3%. We expect this strong economic growth to translate into further profit growth, which provides fundamental support for stock prices.

Nonfarm payrolls came in below expectations at 559,000 with the unemployment rate falling to 5.8%. The payroll diffusion index ticked up to 62.3%, while its 12-month average hovered above 65% and near its highest level since 1998, indicating broad-based industry participation in the jobs recovery. Given the broad industry hiring participation and a record 8.1 million job openings, we expect further labor market improvements in the coming months.

Layoff trends are also consistent with a healing labor market. Initial jobless claims dropped 20,000 last week to 385,000, a new pandemic low, and below the estimate of 400,000. It was the seventh decline in the past eight weeks, indicating a steady improvement in labor demand and fewer layoffs. This healing labor market further supports the overall economic recovery.

Healthy Consumer Should Support Further Strong Growth

Since the start of the pandemic last March, disposable income has grown at its fastest 14-month rate ever, thanks to generous fiscal transfers in the form of direct payments to over three-quarters of all households and supplemental benefits to the unemployed. The potential for households to spend some of the more than $2 trillion of excess savings they have accumulated since March 2020 should bolster growth across the rest of the year and keep it above trend in 2022—supporting further profit growth.

Global Business Surveys also at Historically High Level

The J.P. Morgan Global Composite Output Index (a survey that includes manufacturing and services surveys in over 40 countries) showed economic growth reaching a 15-year high in May as the rapid U.S. and European recovery offset a subdued Asia region. Growth in China eased, while Japan and India fell back into contraction. The U.S. and Europe are beneficiaries of the vaccine rollout and economic reopening and remain well-positioned markets.

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