Stocks had another good week and the S&P 500 Index is now up 14.8% year-to-date as we approach the halfway mark for the year.
We continue to maintain an optimistic outlook for the year and expect the successful reopening to transition to a sustainable economic expansion, despite concerns over near-term inflation pressures and fading fiscal stimulus.
Current Economic Readings Historically Strong: Markit’s preliminary manufacturing business survey for June rose to a record high with new order growth remaining robust. Markit’s preliminary service sector business survey recorded its second-highest reading on record with new order growth remaining near an all-time high. While supply chain problems and labor shortages remain a concern, we expect these to be resolved in the coming quarters (discussed below).
These early readings of June’s activity suggest further impressive growth for the U.S. economy, rounding off an unprecedented growth spurt over the second quarter as a whole. Indeed, the consensus estimate for second-quarter economic performance is calling for over 9.0% growth.
Global Backdrop Continues to Improve: We also received preliminary business surveys for Europe last week that show its economy is experiencing a successful reopening, with Europe several weeks behind the U.S. with its vaccine rollout. The IHS Markit Flash Eurozone PMI Composite Output Index showed eurozone business activity growing at the fastest rate for 15 years in June as the economy reopened further from virus-fighting restrictions and vaccine progress boosted confidence.
Importantly, European business confidence in the outlook rose to its highest reading since future sentiment data was first available in 2012, buoyed by the recent surge in demand and prospects of the economy opening up further in coming months.
We expect further improvements in the global backdrop as vaccinations progress in other countries, economies reopen and the pandemic ultimately fades. This should provide additional support to the already successful U.S. economic recovery.
We Still View Current High Inflation as Transitory: Most of the recent high inflation readings can be attributed to temporary reopening factors that should subside in the coming months. We expect supply chain bottlenecks to ease with prices of various key inputs—ranging from lumber, steel, soybeans, corn, to DRAM prices—already falling.
In addition, more than half of the increase in consumer prices in April and May can be explained by higher vehicle prices, along with a rebound in pandemic-affected service prices (airfares, hotels, and event admissions). Outside of those sectors, the level of the Consumer Price Index remains below its pre-pandemic trend.
Moreover, labor supply should rebound significantly by year-end as coronavirus concerns continue to diminish and temporary supplemental unemployment benefits expire. This should ease wage pressures and reduce concerns about persistently high inflation in coming years. All of this should take pressure off the Federal Reserve to pull forward the timeline for raising interest rates, which could cause stock market volatility.
Expecting Successful Handoff to Private SectorWhile the economy has benefitted from massive fiscal stimulus that will fade into year’s end, we are confident that a sustainable economic expansion will be powered by consumption led by job and wage growth. With a historically high 9.3 million job openings, we expect further strong labor market gains into year’s end, especially as supplemental unemployment benefits expire in September. Employment and wage gains, coupled with excess savings estimated at about $2 trillion and record-high consumer net worth, should allow for a successful transition to a sustainable private-sector-led expansion.
A healthy, growing economy supports corporate profit growth and has us remaining favorable on cyclical stocks, including the Financial, Energy, Material, and Industrial sectors.
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