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Where do we go from here? Consumers & inflation

July 6, 2021

and Laura Kuntz

Many areas of the stock market have continued to be exciting in 2021 as the U.S. — and increasingly other countries — have begun moving away from the COVID-19 lock down. It is such a pleasure to see clients who visit our office, though we continue to value our clients’ preferences for video/telephone connection.

The stock market is not the only big story of 2021. The Biden administration tax proposals are another. In our regular meetings together, we plan to address any tax impacts we see for you. Please let us know your questions on these or any other area!

Recovery

Restaurants, stores, and planes are crowded with Americans excited to get back to their lives and compensate for postponed experiences. U.S. airline passenger volumes have recovered to 75% of the pre-pandemic level. Americans are expected to spend a record amount on summer travel, according to Allianz Vacation Confidence Index.1

54% of Americans have had at least one shot, short of President Joe Biden’s goal of 70% of Americans vaccinated by July 4th, but noteworthy progress considering the pandemic and vaccine outlook a year ago. Only 23.4% of the world population has received one dose, up from 20.9% two weeks ago.2

The more infectious and dangerous Delta variant is becoming the dominant strain, threatening global recovery, especially in emerging markets. Fortunately, the Pfizer, AstraZeneca, and Moderna vaccines have all shown effectiveness against the Delta strain.3

We are largely optimistic on the global vaccine rollout, although we expect fits and starts in implementation. We’re therefore also optimistic in the global economic recovery. We also think this positive outlook is already substantially reflected in the investment markets and asset prices.

Consumer confidence and growth

In the U.S., rising consumer confidence bolstered by a “wealth effect” from asset prices has propelled economic growth forecasts for 2021 to 6.6% year-over-year.4 U.S. economic growth estimates have already increased 2.5% during the year. Growth could surpass the 1984 level of 7.3% (the prior 60-year record).  In June, the U.S. consumer confidence index rose 6% from the prior month, ahead of all forecasts in the Bloomberg survey of economists.6,7

Although most stimulus-related unemployment benefits have already been sent to U.S. consumers, the Child Tax Credit coming into effect on 7/15 could support consumer spending further. In addition, the forecasted job growth in the back half of the year could drive spending power over the coming months.8

We are largely in line with the consensus forecast of strong U.S. consumer spending for the rest of 2021. We think spending could shift more from goods to services, i.e., shift from things consumers want for their homes to things consumers want to do.

Beyond 2021, the infrastructure bill, if passed, could further support domestic output and consumer spending.9

Unique inflation

Breaks in the global supply chain, labor shortages, and rising consumer spending are causing price increases, i.e., inflation from timber to ridesharing services. Over the past 3 months, the core Consumer Price Index (CPI) (excluding food and energy) has increased at a 5.2% annualized pace, which is the fastest rise since 1991.10 The shortage of used cars in the U.S. and the semiconductor shortage (also impacting auto prices) was responsible for a substantial portion of core inflation in the first half of 2021.11

Some areas of the market are falling from record highs. Timber, for example, is coming down from high prices that were driven by supply shortages in new home construction and remodeling. Other sectors, however, remain elevated. Home prices were up 14.6% year-over-year in April, as indicated by the Home Price Index (Case-Schiller HPI). Many of us have heard the story of a would-be homebuyer pledging to name her first-born after the home seller.12

What do currently higher prices mean to many areas of the stock market? We largely agree with Federal Reserve Chairman Jerome Powell’s forecast that many recent price increases will dissipate over the next 24 months and that inflation will drift towards a 2% goal. However, we think price inflation may weigh modestly on consumer spending levels over the short term or possibly even weight modestly on corporate profits if companies are not able to pass along price increases.13 That said, our expectation over 12 to 24 months is that positive consumer spending will likely trump inflation effects.

Bonds regained some ground

Over the past three months, we have seen generally good news in the U.S. bond markets. As an example, the U.S. Aggregate Bond Index recovered 1.93% from April 1 to June 30, 2021. The 10-year treasury yield fell from 1.74% to 1.54% over the quarter, and the 30-year fixed mortgage rate fell from 3.33 to 3.18%.14

Careful positioning by the Federal Reserve Board this year should reduce the risk of a repeat of 2013’s Taper Tantrum, when investors dumped risky assets in favor of bonds, fearing lack of monetary support.15

Although it can be challenging to retain bonds during an aggressive economic expansion, we continue to strongly believe that a diversified bond allocation (as suitable) will provide important protection for our clients during times of market volatility,16 including likely upcoming market corrections. In addition, as we continue to overweight stocks 5% (as suitable), bonds are automatically under weighted.

Stocks and the year ahead

Stocks had one of their best half-years in 2021. The S&P 500 climbed 8% during the past quarter, up 14% for the year. Expectations for corporate earnings for companies in the S&P 500 have moved 15% higher over the course of the year. Analysts are expecting 2Q 2021 corporate earnings to beat estimates at twice the historic level.17

The index results we have included indicate a divergence in year-to-date results between U.S. and international stocks. We believe that this difference will be resolved as vaccinations increase across the world.

2021 index returns

Where do we go from here? If earnings continue to be revised higher through 2022, which is the current consensus, we think equity markets bolstered by consumer spending have room for continuing expansion (with corrections along the way). We believe the continued recovery globally, the resumption of travel, and strong consumer confidence will provide room for expansion over the next 12-24 months. Our outlook continues to be moderately bullish on stocks, driving the 5% overweight (as suitable) based on our viewpoint that the expansion phase of the cycle still has room to run.


Footnotes

1. The Air Current and Travel Pulse
2. Washington Post and Fortune
3. Bloomberg and Bloomberg
4. Raymond James Research
5. Raymond James Research
6. Bloomberg
7. Note: In the U.S., the consumer is queen/king – US consumer spending accounts for 70% of the economy, which is the highest proportion in comparison with large, developed economies. FRED Economic Data
8. Raymond James Research
9. CNBC
10. Bloomberg
11. PIMCO
12. Financial Review
13. JP Morgan Research
14. JP Morgan Research
15. Bloomberg
16. Morningstar Data
17. Raymond James Research, JP Morgan Research

Important information

The information on this and the previous page is not intended as a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended for a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for every investor. Investing involves risk and investors may incur a profit or a loss, including the loss of all principal. Please note that international investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. This may result in greater share price volatility. These risks are heightened in emerging markets. Diversification does not assure profit or protection against loss. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. Holding bonds to term allows redemption at par value. Bond prices and interest rates have an inverse relationship. Dividends are not guaranteed and must be authorized by the company’s board of directors. No one graph, chart, formula, or software can in and of itself be used to determine which securities to buy or sell, when to buy or sell them, or assist any person in making decisions as to which securities to buy or sell or when to buy or sell them. Any chart, graph, formula, or software used is limited by the data entered and the created parameters. Market performance results were obtained from Tamarac.

Definitions

S&P 500: Representing approximately 80% of the investable U.S. equity market, the S&P 500 measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested.

MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. As of June 2, 2014, the index consists of 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

BBG Barclays Aggregate Bond: A representation of SEC-registered, taxable, and dollar denominated securities. The index covers the U.S. investment grade fixed rate bond market, with index components for asset-backed securities, government and corporate securities, and mortgage pass-through securities. Must be rated investment grade (Baa3/BBB- or higher) by at least two of the following rating agencies: Moody’s, S&P, Fitch; regardless of call features have at least one year to final maturity and have an outstanding par value amount of at least $250 million.

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