Pent-up Demand Fuels Economy

Posted by Trust and Investment Management Services Team on Aug 6, 2021 12:00:00 AM

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Economic indicators are proving that consumers and businesses are fueling the economy with pent-up demand on spending. Consumers are reacting to the vaccinations with robust spending on vacations, furniture, automobiles and homes, while businesses are trying to ramp up production and services to meet the need.

With GDP growing at 6.5% and now back to pre-pandemic levels, this pace is not sustainable and should decelerate in the coming quarters. This does not foreshadow a recession: the economy is returning to steady 2-3% sustainable growth with stable employment and lower inflation. GDP growth would have been stronger if supply chains, home building, and product delivery had not been suppressed by inventory and labor shortages.

With employment growing, the Federal Reserve has begun discussing tapering of their accommodative policy by decreasing their bond purchases. A year ago, the Fed purchased $80 billion per month in Mortgage-Backed Securities; last month, that declined to $40 billion, so the tapering has already been slow and methodical. The Fed has been the largest buyer in the bond market, and it is time to reduce the subsidization of growth and let the markets operate normally. There is some recent evidence that the spread of the Delta COVID variant is delaying global commerce and may slow demand and production as well as inflationary pressures. This has caused the 10-year U.S. Treasury yield to decline to 1.18% even though the recent inflation rate is over 5%.

The equity markets are supported by lower interest rates and by the tremendous year-over-year growth in earnings. Most large companies are reporting record revenues and earnings while raising dividends and providing upbeat forecasts. The energy, industrial, and financial sectors are leading the market higher, while utilities and consumer staples are underperforming. International stocks generally are still underperforming the U.S. as health, economic policy, currency, and social issues continue to deter growth. China’s equities are experiencing serious turmoil as the benevolent Communist Party has transitioned to a ruthless interventionist. The government has recently declared that video games are “spiritual opium” and is investigating possible chip price manipulation. For-profit Chinese education companies are now nonprofit, and China is tightening regulations on financial companies. With this kind of capricious government activity, China is becoming an unattractive country for investors.

The delivery of growing earnings in a dynamic economy will continue to support the U.S. market valuation. With value stocks slightly underperforming growth stocks recently, it is important to diversify and have a balance of equity investments. We still like the industrial, information technology and energy sectors most. With the S&P 500 Index combined earnings expected to be approximately $220-$240 per share, the market is trading at a slight historical premium at 20x earnings (18.6% is the historical norm). There is still upside to the equity markets through year-end, but August and September typically provide volatility.

Index Total Return through 7/31/2021
S&P 500 Index                    17%
S&P 400 Mid Cap Index    17.2%
 Russell 2000 Index            12.7%
MSCI AWCI                           12%

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Topics: Market Update, Economy