The first half of 2021 brought better than expected stock market returns and an overall economic recovery amidst a successful vaccination rollout in the United States. However, lingering disruptions to the supply chain and job markets could bring a volatile end to the year.
• The S&P 500 gained 8.5% in the second quarter and is up 15.2% year to date. A rally that began in November has essentially continued uninterrupted. A Refinitiv tracker showed that 87% of S&P 500 companies beat their earnings estimates, which set a record since they began tracking that metric in 1994 and sits well above the 65% average.
• Due to the strong earnings results, the price-to-earnings ratio contracted to 21.5 times earnings from a high of over 22x in January. This still sits above the 16.7x average for the last 25 years.
• Inflation has been the key buzzword of 2021 as economists debate whether we are in a transitory environment, or if inflation will be sustained. An argument for transitory could be seen in lumber prices, which started the year at $717 per thousand board feet, peaked at $1,671 on May 7th, and now sits at $787. Speculative trading action has cooled as homebuilding demand has eased.
• On the other hand, Federal Reserve chairman Jerome Powell admitted in June that inflation had come in above expectations, noting that Fed officials expected to begin raising interest rates in 2023, sooner than previously planned. With personal savings rates at 15% in April and wage growth of 4.9% compared to 2019, Americans can afford more of everything. If interest rates go up even earlier than 2023, the market is bound to punish stocks that can’t borrow as cheaply anymore.
• The price of oil has rallied to its highest price in three years, as supply has lagged demand for increased travel desires. This transitory versus long-term debate will also be one to watch.
• Nevertheless, the global economy is humming along, with the global Purchasing Managers’ Index (PMI) hitting its highest level in 15 years. Manufacturing has steadily increased, while services have snapped back with restaurant and travel restrictions lifted. There will also be a debate as to whether that activity can sustain or will prove transitory.
• A global minimum tax rate of 15% seems certain to be enacted with 130 countries agreeing to participate thus far. That could hurt the profits of technology and energy companies, who have historically domiciled in lower tax countries. As the Biden administration also debates increasing the corporate tax rate of 21% to help pay for infrastructure spending, stocks could face headwinds moving forward.
Barring a significant negative event from a COVID variant, we should be returning to a more “normal” economy to finish 2021. This could lead to higher inflation as well as to investors being less forgiving to companies who have yet to show a profit, and it remains to be seen whether “meme stocks” such as GameStop or AMC Theatres can sustain recent run-ups.
Finally, it’s important to remember in a typical year the S&P 500 drops about 14% on average. As we only had a decline of about 4% earlier in the year before setting new recent highs, we may be due for a similar decline, particularly if wage and price inflation appear to be increasing faster than even the Federal Reserve would like to see.