As we embark on the second half of 2021, both the US economy and stock market continue to strengthen at a rapid pace. The Congressional Budget Office expects the US economy to grow by 7.4% this year with strong corporate earnings fueling further gains in employment. The US economy continues to re-open and normalize while pent up demand in consumer goods and travel and leisure is pushing prices higher. According to JPMorgan, the total number of jobs currently available is closing in the total number of unemployed Americans.
Strong economic activity has been bullish for equities as the S&P500 has climbed 15.25% for the first half of this year as investors have focused on cyclical stocks over defensive ones. Energy stocks (+45.6%) surged this year as oil prices rebounded to meet rising demand, while utilities (+2.38%) have lagged. Technology stocks came back in favor in June, gaining 6.95% after lagging the broader market this year. Steep valuations and potential government regulation have given investors pause after the sector led the market higher for much of 2020. Small caps, which tend to do well when the economy is strong, have outpaced large caps, gaining 17.54%. Overall, risk taking has paid off for investors as the market has experienced low volatility levels in the first six months of 2021. There has been only 4 days where the S&P500 closed +/-2%. The summer months may see higher levels of volatility where there tends to be liquidity, potentially higher unexpected inflation and new COVID variant threats.
Inflation is rising as demand is picking up in many areas of the economy. Higher prices for everyday goods and services typically is met by higher interest rates, as lenders require additional compensation for lost purchasing power when they are repaid. However, interest rates have been declining after peaking in March. Part of this phenomenon can be explained by the massive amount of liquidity that the Federal Reserve is pumping into the system. Part can be explained by investors moving out on the yield curve to earn something above flat money market yields. Temporary inflation is likely being priced into the bond market, so higher unexpected inflation may lead to a spike in yields on the long end of the curve with the Fed increasing yields on the short end to keep the economy from overheating. That hardly seems like a risk today with 9.5 million Americans unemployed.
The second half of 2020 looks promising assuming the aforementioned risks remain contained. While stocks here in the U.S. are at or near all-time highs, a strong economy and healthy employment levels should bode well for corporate earnings. Europe and Asia (ex-China) are a few months behind the U.S. but continue to open and strengthen. The global economy could be on a strong trajectory for some time. Investors should continue to remain globally invested to capture the potential resurgence abroad.
Sources: Morningstar Direct, JPMorgan, First Trust, Wall Street Journal