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, 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. 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. 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, 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.
 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  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  Semiannual Monetary Policy Report to Congress July 14, 2021, https://www.federalreserve.gov/newsevents/testimony/powell20210714a.htm  Market Insights – Guide to the Markets July 31, 2021, https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/