{"id":385,"date":"2021-07-14T20:06:34","date_gmt":"2021-07-14T20:06:34","guid":{"rendered":"https:\/\/winthropcm.com\/reports-and-profiles\/?p=385"},"modified":"2021-07-15T19:49:10","modified_gmt":"2021-07-15T19:49:10","slug":"3q-economic-capital-market-outlook","status":"publish","type":"post","link":"https:\/\/winthropcm.com\/reports-and-profiles\/3q-economic-capital-market-outlook\/","title":{"rendered":"3Q Economic & Capital Market Outlook"},"content":{"rendered":"\n

The U.S. economy has rebounded from the carnage caused by the pandemic. With the help of massive monetary and fiscal stimulus, Gross Domestic Product (GDP) grew at a rate of 6.4% in the first quarter of this year and inflation, measured by the Consumer Price Index (CPI), has increased 5% over the past year according to the Bureau of Labor Statistics. The Federal Reserve has been waiting desperately leading up to the pandemic for this scenario, and now the Fed has finally got its wish of GDP growth and a rate of inflation over 2%.<\/em> <\/strong><\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

There are two tests to sustained economic growth over the next six months: The first is the ability to contain the spread of the delta variant of the COVID-19 virus spreading through the United States. The second is the upcoming withdrawal of government support to the consumer. In spite of the upcoming expiration of much of the massive fiscal stimulus put in place to support the impaired economy during the pandemic, we expect GDP to continue to post strong growth in the second half of 2021 as more of the economy reopens. In turn, economic growth will support the labor market as workers move back into jobs, ultimately putting pressure on wages. With yields on the 10-year U.S. Treasury note diving to 1.29% recently, the bond market is currently not pricing the economic recovery and higher inflation coming down the road.<\/strong><\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

We are not concerned about the elevated rate of inflation. The current inflation rate is a result of structural issues resulting from the pandemic\u2019s impact on the economy. These include supply-chain disruptions, such as a shortage of computer chips, and tight housing supply. We expect the rate of inflation to begin to decline in the second half of the year, but remain above the Fed\u2019s 2% target.<\/p>\n\n\n\n

Ultimately, the consumer will drive the economic recovery from this point. Consumers received a massive benefit from the fiscal stimulus provided during the pandemic. The question now is, \u201cWill the consumer continue to spend after the stimulus is removed?\u201d We think the answer is yes.<\/p>\n\n\n\n

The personal savings measured by the U.S. Bureau of Economic Analysis (BEA) sits at $4.2 trillion at the end of the first quarter, which is an increase of $3 trillion over pre-pandemic levels. With the improvement in the labor market and the increased savings, we believe there is sufficient fuel to support consumer spending well into the second half of the year.<\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

At the same time, the imbalance between the savings accumulated during the pandemic and student loan debt continues to grow, reaching $1.7 trillion, a growth rate six times faster than the economy. With the withdrawal of stimulus and protections provided during the pandemic, we expect there will be a large part of the population that will be negatively impacted through higher debt levels, reduced unemployment benefits and eventual removal of eviction protection.  <\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

The corresponding increase in asset prices is a natural result of the massive fiscal and monetary stimulus and has made investment decisions more challenging. Our scenario of higher growth supported by higher inflation would naturally lead to higher interest rates. Historically, rising interest rates have been disruptive to equity markets. There is a lot of good news priced into the equity market, including remarkable earnings in the first half of the year. We expect rising rates to be a major threat to current equity valuations. <\/p>\n\n\n\n

The Economy<\/strong><\/h4>\n\n\n\n

The domestic economy continues to show strong growth with the BEA posting first-quarter GDP growth of 6.4%. This reflects the continued recovery throughout the economy and the reopening of restaurants and entertainment following the pandemic. The strength of the recovery continues to be supported by the government\u2019s response, through both fiscal and monetary initiatives.<\/p>\n\n\n\n

The labor market remains a critical factor to a sustained recovery and there has been significant improvement so far this year. Through the first half of the year, filings for weekly unemployment benefits have declined from 900,000 to nearly 370,000. The unemployment rate has remained around 5.9% and the June jobs report showed employers added 850,000 jobs, the largest gain in 10 months.<\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

According to the Labor Department report, there were a record 9.2 million job openings in May and 9.3 million unemployed workers looking for jobs. As a result of the pandemic, a number of challenges are facing workers going back to work, including obtaining childcare, extended unemployment benefits that are making low wage jobs less attractive, and remaining fears around the COVID-19 virus. While the job market is experiencing structural challenges getting people back to work, it is still very strong. Many of the impediments to getting people back to work will decline over the next quarter as schools move back to in-person learning and the enhanced unemployment benefits come to an end. We expect to see some increased wage pressure as incentives increase for a competitive labor market.<\/p>\n\n\n\n

Employment drives consumption. The Consumer sector has been heavily supported by government assistance, including extended unemployment benefits, rent relief and student loan forbearance. However, much of this support is expected to end this quarter and will place more of a burden on the economy. Households increased savings to $2.5 trillion in their bank accounts through the pandemic and we expect some of that to transition into consumption as the economy reopens, which will support continued growth in the second half of the year.<\/p>\n\n\n\n

For the most part the recovery is broad based across the economy. The increase in first-quarter GDP reflects an increase in personal consumption expenditures, nonresidential fixed investment, federal government spending, residential fixed investment, and state and local government spending that were partly offset by decreases in private inventory investment and exports. The recent spike in oil prices, while not a major surprise, should not be a significant impediment to the economy. We expect oil prices to normalize late this year as OPEC figures out its production quota and U.S. shale production increases.<\/strong><\/p>\n\n\n\n

Monetary Policy<\/strong><\/h4>\n\n\n\n

The Federal Reserve has provided aggressive support to the economy and capital markets by maintaining a low target for short-term interest rates and aggressively buying bonds onto its balance sheet. The Fed has accumulated over $7.5 trillion in securities on its balance sheet through June, all in an effort to support lower interest rates and massive deficit spending.<\/p>\n\n\n\n

With the strength of the economic recovery, improvement in the labor market, and the acceleration in the rate of inflation, we expect the Federal Reserve to begin to message to the market a plan to reduce its bond purchase program and allow interest rates to adjust higher toward the end of this year. However, the Fed has clearly indicated that they do not see a case to raise rates any time soon. After years of attempting to push inflation toward its 2% target, the Fed has finally gotten inflation over its target with CPI coming in at an annual rate of 3.8% in May according to the Bureau of Labor Statistics.<\/p>\n\n\n\n

We expect the Fed will risk a policy mistake if it allows easy money to persist for a prolonged period. The amount of money in the system, measured by M2, has increased an astounding 25% over the past year. As a result, deposits have increased at the banks, but loan growth is substantially slower than deposit growth. With the demand for credit so weak and the supply of money so large, the Federal Reserve is facing a critical point in its current policy. The Fed\u2019s continued purchase of bonds through its quantitative easing program at the rate of $120 billion per month in order to support lower interest rates as the economy expands, and the pace of inflation spikes appears to be overly aggressive in light of the improvement in economic activity.<\/p>\n\n\n\n

We expect, until there is strong evidence that the labor market has adjusted back to pre-pandemic levels, the Federal Reserve will continue to talk interest rates lower. However, we believe if we remain on the current path of economic growth, the Fed will need to adjust the process to move interest rates higher by next year.   <\/p>\n\n\n\n

Equities<\/strong><\/h4>\n\n\n\n

The domestic equity market has shown remarkable resilience through the pandemic and domestic equity indices closed the send quarter near record levels. The S&P 500 increased a remarkable 16.3% through the first half of 2021 as the economy recovers from the brutal impact of the pandemic.<\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

At the current level of 4350, valuations remain elevated with the S&P 500 currently trading at 24.9 times forward earnings of $175. Valuations increase during periods of aggressive stimulus and can remain elevated for prolonged periods. Assuming historic earnings growth of 9.3%, we believe fair value for the S&P 500 is near 4100.<\/p>\n\n\n\n

One of the key drivers for equity valuation will be President Biden\u2019s tax policy and its impact of dividends and share repurchases. Biden\u2019s plan considers taxing share repurchases at the same rate as dividends. Companies that weathered the storm brought on by the pandemic are now flush with cash and buying back their stock at prices near all-time high levels. So far this year, Apple, Google, Goldman Sachs, and JP Morgan have announced significant share-repurchase programs.<\/p>\n\n\n\n

Fixed Income<\/strong><\/h4>\n\n\n\n

No market has benefited more from government intervention than the U.S. bond market over the past year. Interest rates declined sharply and credit spreads tightened as the Fed increased its bond purchase program and investors gobbled up new issue credit and structured securities.<\/p>\n\n\n\n

Through the year, bond yields have traded in a fairly narrow range. Since the beginning of the year, the yield on the 10-year U.S. Treasury has declined from a yield of 1.75% to settle in at 1.40% at the end of the quarter. At the same time, credit spreads have tightened. The Bloomberg Barclays US Credit Investment Grade index tightened by 12 bps and the Bloomberg Barclays High Yield Index tightened by 93 bps.<\/p>\n\n\n\n

\"\"<\/figure><\/div>\n\n\n\n

With obvious exceptions in the Travel, Leisure and Retail sectors, credit quality has held up well during the past year. We expect credit quality to remain solid and begin to improve as companies that took on debt during the pandemic begin to take steps to reduce leverage.<\/p>\n\n\n\n

While fixed income remains one of the best uncorrelated asset classes, expected returns over the next year will be below 3%, assuming the Fed begins pushing interest rates higher.<\/p>\n\n\n\n

This report is published solely for informational purposes and is not to be construed as specific tax, legal or investment advice.  Views should not be considered a recommendation to buy or sell nor should they be relied upon as investment advice.  It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors.  Information contained in this report is current as of the date of publication and has been obtained from third party sources believed to be reliable.  WCM does not warrant or make any representation regarding the use or results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use.  You should assume that Winthrop Capital Management has a financial interest in one or more of the positions discussed.  Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.  Winthrop Capital Management has no obligation to provide recipients hereof with updates or changes to such data.<\/em> <\/em><\/p>\n\n\n\n

 <\/em>\u00a9 2021 Winthrop Capital Management<\/em><\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

The U.S. economy has rebounded from the carnage caused by the pandemic. With the help of massive monetary and fiscal stimulus, Gross Domestic Product (GDP) grew at a rate of 6.4% in the first quarter of this year and inflation, measured by the Consumer Price Index (CPI), has increased 5% over the past year according […]<\/p>\n","protected":false},"author":3,"featured_media":394,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/385"}],"collection":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/comments?post=385"}],"version-history":[{"count":1,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/385\/revisions"}],"predecessor-version":[{"id":393,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/385\/revisions\/393"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/media\/394"}],"wp:attachment":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/media?parent=385"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/categories?post=385"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/tags?post=385"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}