Halftime report: Markets in 2021
Record highs for stocks, inflation spikes, a race to vaccinate and trillions in stimulus. A recap of what’s shaped the investment landscape so far this year.
Our Top Market Takeaways for July 1, 2021.
2021 Halftime Report
When we started 2021, investors were holding onto hope—for a sustained economic bounceback, for assets to prove worthy of their valuations, for vaccines to enable a return to normalcy, and for policymakers to keep a steady hand. As we head into the Fourth of July weekend, those hopes have largely become realities.
Below, we take a look at how those developments shaped the investment landscape in the first half of the year. Let’s dive in.
1. Markets: Reflation, realized.
The market mood has been decidedly risk-on in 2021 so far. Broad commodities, boosted by reflationary dynamics and global demand for goods, are leading the way. Global equities are up double digits.
- This is the strongest 1H rally we’ve seen for broad commodities since 2008. The rebound in global growth has spurred demand for reflationary assets such as commodities, which are up nearly +57% from their Virus Crisis lows (although they’re still about -60% below their pre-GFC peaks). Broadly speaking, we think sustained global demand will keep commodity prices supported this year.
- Earnings have been the overwhelming driver of stock market returns in all regions (except China) as valuations have contracted. On a 12-month trailing basis, U.S. companies’ earnings have grown +25%. The first quarter of 2021, in particular, delivered some of the most exceptional results from S&P 500 companies in modern history—earnings beat expectations by over 20% and grew 50% year-over-year. Meanwhile, the S&P 500’s forward multiple has fallen more than a full turn since the start of the year (from 22.4x to 21.3x). Similarly, Developed Markets ex-U.S. and Emerging Markets have seen earnings growth of 29% and 22%, respectively, and their forward multiples have fallen.
- Since 1928, in years when the S&P 500 has risen 10%+ in the first half of the year, full-year returns finished positive 28 out of 30 times (the exceptions were 1929 and 1987). In 22 of those 30 years, the S&P 500 moved higher still in the second half of the year (which is our base case for 2021). Year-end is by far the most common time for the S&P 500 to make its annual high. The market has made its yearly high in December roughly one-third of the time throughout its history, and nearly half the time if we include November.
2. Inflation: The worst of inflation fears may be behind us.
The Fed did its part in calming runaway inflation fears when the FOMC dots signaled that rate hikes could start sooner (we went from zero hikes in 2023 on the March dot plot to two hikes in 2023 on the June dot plot). But it seems inflation fears may have peaked in the middle of May.
- Around the time of the release of the decidedly “hot” April CPI report on May 12, a number of assets linked to the inflation story peaked, including Treasury breakevens, lumber prices and corn prices.
- Meanwhile, stock market segments deemed to be likely victims of an abundant growth, high inflation environment took a turn for the better. After tepid starts to the year, the S&P 500 tech sector is up +13% and the NASDAQ 100 is up +12% since the middle of May.
- Inflation figures have been distorted to the upside by various supply bottlenecks, but we still expect them to be temporary. Some bottlenecks may take longer to clear than others (e.g., semiconductors, one culprit in car prices’ eye-popping rise), but we’re looking for overall price increases to moderate through year-end and into 2022. Relatively sluggish recoveries in housing rental prices and the labor market underscore our view that the broader inflation picture isn’t alarming at this time. Speaking of…
3. Jobs: Plenty of progress to be had.
By the time the United States had entered its most stringent lockdown period in April 2020, over 22 million American workers had been laid off. Midway through 2021, we’re still more than seven million jobs below peak pre-pandemic employment, with total non-farm payrolls having recovered only about two-thirds of lost jobs.
- If anything is holding back the labor market recovery, it may be workers’ willingness to get back to it. The Job Openings and Labor Turnover Survey (JOLTS) from April showed that U.S. job openings and the quits rate had reached series highs of 9.3 million and 2.7%, respectively. Businesses want to hire, but they either can’t find the right help or haven’t found a wage high enough to entice the skeptical prospective employee.
- We wouldn’t be surprised to see labor market gains pick up in the months ahead, given three factors: the expiration of supplemental federal unemployment benefits at the end of September; the mitigation of COVID-19 infection risk, given widespread immunity from vaccinations and prior infections; and the return of in-person school in the fall (which could get dependents out of the house and enable caretakers to return to work).
- The leisure & hospitality sector represents ~33% of unrecovered jobs. As reopening enables the resumption of high-contact activities such as travel, sports, concerts and dining out, we expect more of these jobs to come back. That said, we’re monitoring the labor market for longer-term scarring. Some job losses may be permanent due to retirement, or outdated or mismatched skill sets, making it harder for those in that category to find jobs again without some form of retraining.
4. COVID-19: The effective end of the pandemic for some, but an ongoing global tragedy.
For most in the United States, the pandemic is effectively over thanks to quicker-than-expected vaccine rollout and the broad-based removal of restrictions. The situation continues to improve in many parts of the developed world, but both the global year-to-date case count and death toll already exceed 2020’s full-year totals (cases: 98.0 million YTD in 2021 versus 83.5 million in 2020; deaths: 2.1 million YTD in 2021 versus 1.9 million in 2020).
- The emergence of highly contagious strains such as the Delta variant poses risks for individuals without immunity, but the Pfizer and Moderna vaccines have proven effective against even those mutations. This offers confidence that economies with high vaccination penetration will be able to avoid new rounds of lockdown measures.
- Investors seem to acknowledge that the virus is no longer posing a dire threat to the outlook for developed world economies and markets, and the Fed validated the reduction of that risk in its June FOMC press conference.
- Our forward-looking outlook emphasizes the ongoing evolution from early-to-mid cycle, corporate earnings, and the path of policy. We’re past the peak of global policy support, but are confident that recovery momentum will continue to sustain the expansion.
5. Policy: Peak support has passed.
Monetary and fiscal policy support “bazookas” yielded financial conditions (which measure how policy is transmitted to the economy) that are about as easy as they’ve ever been, which has helped sustain the recovery in 2021 so far. It seems that the only direction in which we can go from here is toward more restrictive policy, but we expect that to be a gradual process.
- On the monetary policy side, we are at ease with the likelihood of Fed tapering beginning at the start of 2022. As for rate hikes, our base case remains that the Fed will first move in the second half of 2023.
- The passage of the $1.9 trillion relief bill in March brought the total U.S. fiscal response to the pandemic to more than $5.2 trillion—2.8x larger than the total U.S. fiscal response to the Global Financial Crisis. Although such measures caused U.S. federal debt to balloon to over 120% of GDP, the government’s total cost of servicing that debt (measured by interest expense as a percentage of GDP) is as low as it was in the early 2000s.
- An infrastructure bill could offer another boost to growth in the United States, but the impact will be more gradual as spending rolls out over multiple years.
As we look ahead to the second half of 2021, we believe growth will fuel more upside in markets. We still like stocks over bonds, and bonds over cash. Approach risk-seeking portions of portfolios with balance (between growth and value, U.S. and ex-U.S. allocations), consider tools beyond traditional fixed income to find yield and insulate portfolios, and be mindful of rising rates where there’s floating rate liability exposure.
All market and economic data as of July 2021 and sourced from Bloomberg and FactSet unless otherwise stated.
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