With stocks reaching new highs on a regular basis, we are often asked what can provide future support for the market.
While stock market corrections can occur at any time—a typical year experiences a 14% correction with stocks ultimately up by 10% in a typical year—we see several major factors that should provide support for the market as we move through the back half of the year.
A healthy economy provides the fertile environment for corporate profitability, which is the ultimate support for stock prices. Ever since the economy emerged from last spring’s hard lockdown, we have been experiencing a sharp rebound in economic activity. We continue to see healthy economic readings, which suggest a sustainable economic recovery is unfolding with a successful handoff from government support to the private sector. Last week provided more encouraging economic signals.
June retail sales came in above expectations, increasing 0.6% month/month (18% y/y) with broad participation across categories. We are seeing a hand-off from sectors that benefitted from the pandemic (furniture down 3.5% m/m and autos down 2.0% m/m) to sectors that benefit from the reopening (restaurants up 2.3%, apparel up 2.5% and department stores up 5.9%). We think these favorable trends will continue and see job growth, wage gains, and excess consumer savings replacing government stimulus as the fuel for the economy.
The NFIB Small Business Optimism Index increased in June to an eight-month high. It was up in four of the past five months, and by the most since last September, indicating improving business confidence, which bodes well for the economic recovery. Importantly, job openings and hiring plans for the next three months hovered at or near record highs. Firms continued to report record-low inventories and a desire to replenish those inventories in the coming months, which bodes well for future economic growth.
We continue to see improvement in the labor market and expect further gains in the coming months. Initial claims for unemployment insurance fell 26,000 last week to 360,000, another pandemic low. Continuing claims also fell and is at the lowest level since March 2020. With job openings standing at a record high of 9.2 million, we anticipate substantial job gains in the coming months, especially as federal supplemental unemployment benefits expire in early September and schools reopen in the fall.
Strong Federal Reserve Support
Ever since the start of the pandemic, the Federal Reserve has been providing unprecedented monetary support with zero interest rates and bond purchases of $120 billion per month. Chairman Powell reiterated his current easy monetary policy stance in testimony before Congress last week. This strong monetary support for the economy remains an important attribute given that major market selloffs are typically proceeded by higher interest rates, which cause recession-like economic conditions.
Stellar Profit Growth
While we are early in the second-quarter earnings season, profits continue to exceed expectations. About 11% of the S&P 500 Index companies have reported second-quarter results with earnings surpassing estimates by 22.1% in aggregate, with 87% of companies topping projections. Second-quarter expectations are for revenues and earnings growth of 20.6%, and 66.4%, respectively. All economically sensitive sectors are projected to grow earnings in excess of 100%: Industrials 330%, Energy 226%, Discretionary 193%, Financials 133%, and Materials 120%. We expect further economic growth to support future profit growth.
Given that about two thirds of economic activity is driven by consumers, a healthy consumer is an important attribute for a sustainable economic expansion. Consumer net worth stands at a record high, debt service levels have plummeted to record lows, while excess savings stands at well over $2 trillion as a result of pandemic savings and federal stimulus payments. Consumer sentiment readings are back to pre-pandemic levels and we expect a strong consumer to support a sustainable economic expansion, especially given pent-up demand and an improving labor market.
Improving Global Backdrop
The vaccine rollout remains 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 a strong recovery and we expect other regions to soon follow.
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