Firing on All Cylinders

The economy continues to fire on all cylinders as COVID-19 vaccinations continue and restrictions on many businesses continue to ease, albeit in fits and starts, given the rise of the new Delta variant. According to the Bureau of Economic Advisors[1], real GDP grew at annual rate of 6.1% in Q1 2021 and posted an initial estimate for Q2 2021 of 6.5%. The Atlanta Fed website www.gdpnow.com is currently forecasting Q3 2021 real GDP growth of 6.1%. If these forecasts hold true as expected the four quarter average for GDP growth will be nearly 5.7%. That’s impressive growth!

Moreover, after falling 22% in 2020, corporate earnings are forecast to increase by 56% in 2021, according to FactSet[2]. The rebound in the economy, corporate profits and accommodative monetary policy by the Federal Reserve has help contribute to  the ~ 18% increase in the S&P 500 this year.  That’s more good news! 

What might be considered bad news is the surge in prices i.e., inflation for things like housing, building materials, and the more volatile food and energy prices. As we discuss below, the current surge in prices could very well prove to be transitory as suggested by Fed Chair Jerome Powell during his recent semi-annual congressional testimony[3]. As we will discuss in our upcoming article, Is Inflation Here to Stay?, this is a key variable that bears watching!

Are we Overvalued, Overextended and Overdue for a Correction?

The fly in the ointment, however, is the rather lofty valuations for stocks, growing speculation among individual investors, technical divergences in the broader market as small cap stocks lag behind FANG and other mega-cap stocks and a rather protracted period of time without the typical 5%-10% intra-year correction.

Regarding valuations, and according to JP Morgan’s Guide to the Markets[4], the S&P 500 trades at 21 times forward earnings, well-above the long-range average of 16.5, which not only exceeds valuation levels seen in 2007, but is also approaching 1999-2000 valuation levels. Undoubtedly, investors will remember the significant declines that followed the bursting of the Tech Bubble in 2000 and the Great Recession in 2007-2008.

Strategy Update While we acknowledge that valuations are “stretched” at present, we remind our readers that, in and of themselves, lofty valuations don’t create bear markets. They can, however, be the burning embers that start a forest fire. Hence, we believe that investors should be vigilant when managing short term volatility over the typically erratic summer months and not be surprised if we see a correction in the broader market over the coming few months. In our view, and assuming that recent inflationary pressures are transitory as we will discuss further in a future article, we view a 5% -10% “correction” in the stock market as a buying opportunity. Having said that, we see a continuation of historically low interest rates coupled with the prospects for stronger economic growth and higher earnings over the next several quarters as bullish for stock prices overall. Moreover, with the 10-year Treasury bond yielding approximately 1.25% it’s reasonable to assume that long-term investors still prefer quality blue chip companies with dividends that exceed 1.25% as a reasonable alternative to bonds. The “TINA” phenomenon (There Is No Alternative) is alive well for the time being. For now, and as we have been for quite some time, we are inclined to allow our equity allocation to drift 3%-5% above our stated neutral targets.
[1] 2nd Quarter 2021 GDP Estimate, Bureau of Economic Analysis July 29, 2021, https://www.bea.gov/news/2021/gross-domestic-product-second-quarter-2021-advance-estimate-and-annual-update [2] Stocks Keep Moving Higher Even As Earnings Estimates Continue to Fall April 28, 2020, https://www.forbes.com/sites/chuckjones/2020/04/28/stocks-keep-moving-higher-even-as-earnings-estimates-continue-to-fall/?sh=57a1b1af5598 [3] Semiannual Monetary Policy Report to Congress July 14, 2021, https://www.federalreserve.gov/newsevents/testimony/powell20210714a.htm [4] Market Insights – Guide to the Markets July 31, 2021, https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/

Student Loan Forgiveness… How Can It Benefit You?

The cost of education continues to rise, so the need for financial aid inevitably becomes more imminent, along with the fear of the financial demands of paying back the money borrowed. Recently, the Biden administration announced its federal Student Loan Forgiveness plan, that is aimed to cancel loans for eligible borrowers. Read more here…

Protect Yourself from Inflation…Invest in I Bonds!

: I Bonds are a U.S. savings bond that are designed to protect your cash from the erosion of your purchasing power, i.e. inflation. With inflation running at a four-decade high, investors are naturally drawn to investments that offer inflation-beating yields. Read more here….

Mid-Year Outlook: Putting the Inflation Genie Back in the Bottle. Can the Fed Engineer a Soft Landing?

As we enter the second half of 2022, investors will continue to face a myriad of economic cross- currents. These include persistently high inflation, the prospect of rising interest rates, economic contraction and falling corporate profits. While it’s too soon to say with confidence… these are the hallmarks of stagflation; an economic scenario that investors have not seen since the 70s. Read more here…