Stocks had a choppy week, but once again reached record highs. We expect stocks to continue benefitting from strong economic and profit growth, despite concerns over further virus headwinds and economic growth off historical peaks.
Despite growth readings receding from historically high levels, we still see indicators that suggest a sustainable economic expansion is underway. Economic growth typically lasts several years past the quarter of peak economic growth and the Federal Reserve has yet to even taper its bond purchases, let alone raise interest rates—typically a major precursor to economic contractions.
While the virus poses a headwind where vaccination rates are low, the vaccine rollout remains very successful with vaccinations accelerating around the globe and vaccine makers on track to produce 10 billion doses in 2021. Regions with high vaccination rates, including the U.S. and Europe, are experiencing strong economic readings and we expect other regions to soon follow.
We also view lower Treasury bond yields and lower commodity prices as a sign of easing reopening inflationary pressures rather than a sign of a significant economic slowdown. Record-high stock prices, historically low corporate bond yields, still healthy economic readings, pent-up demand, record-high consumer net worth, and significant excess savings support this view.
U.S. Business Surveys Support Strong Growth Outlook
While the ISM Services PMI (a timely monthly service sector survey) fell to a four-month low in June, it remains consistent with above-trend growth, albeit with some moderation in activity. The combined latest readings of the ISM Manufacturing and Services PMIs correspond to 5.0% annual economic growth, which is about double the pre-pandemic pace, indicating a strong economic recovery. Supporting this growth outlook, the Atlanta Federal Reserve GDPNow model estimate stands at 7.9% growth for the second quarter, while the Blue Chip consensus is estimating over 9.0% growth.
Labor Market Should See Further Gains
The Job Openings and Labor Turnover Survey (JOLTS) showed job openings tick up to 9.2 million, another record high. This implies almost as many job openings as there are unemployed people (9.5 million). Additionally, layoffs dropped 5.7%, down for the sixth consecutive month, to 1.4 million, a record low. Both indicators reflect stronger labor demand.
Given record job openings, we expect strong job gains in the coming months, especially with the extra federal unemployment benefits officially ending in early September and schools reopening in the fall. Indeed, last week’s sharp decline in continuing claims (145,000), to the lowest level since March 2020, was very encouraging, as was the steep fall in “special” pandemic program claims. Job gains support a sustainable expansion.
Strong Global Backdrop Continues
The J.P. Morgan Global Composite Output Index showed the solid upswing in global economic activity continued at the end of the second quarter. Output expanded at a rate close to May's 15-year high, as new orders remained strong. Given their high level of vaccinations, the U.S. and Europe remained the brighter growth spots. With accelerating global vaccination rates, we anticipate the rest of the world will soon experience the strong improvement we are seeing in the U.S. and Europe.
Strong Second-Quarter Earnings Season Expected
Second-quarter earnings season starts in earnest this week with the consensus expecting 61% year/year earnings growth for the S&P 500 Index, up from 48% last quarter. In part, earnings growth will benefit from base effects. One year ago, S&P 500 EPS fell by 32% as the pandemic sparked a sharp recession. Economic growth is the main driver of earnings growth and, as discussed above, indicators suggest second-quarter economic growth should be historically high. The major banks report earnings this week and are watched closely considering they are exposed to many aspects of the global economy. Like last quarter, Financials are expected to be the primary driver of earnings growth. They are expected to grow earnings by 116% and account for 25% of S&P 500 earnings growth.
The cyclical Industrials (355%), Consumer Discretionary (172%), and Materials (116%) sectors are forecast to lead earnings growth. With oil averaging $33/barrel last second quarter, Energy stocks posted an aggregate net loss. Oil prices averaged $69/barrel this quarter, consequently, Energy firms are expected to return to profitability.
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