August 2021 Market Update
Performance from Feb 19, 2020 through July 20, 2021
- Vaccines, pent-up demand, and expansionary fiscal and monetary policy have driven an impressive economic recovery and strong equity market performance.
- The trends that seemed undeniable earlier in the year—rising inflation, rising interest rates, and the value stock rotation—have come into question at the halfway mark.
- Key Questions to ask: Is the current bout of inflation truly transitory and where might interest rates go from here?
- The COVID-19 Delta Variant is scaring markets, but 2nd Quarter Earnings expectations may overcome short term market fears.
Earnings Expectations are Rising:
- First half market gains were not driven by elevated valuation levels like those seen at the end of 2020.
- Price-to-earnings (P/E) valuations for the S&P 500 have stabilized at approximately 30 times (on a trailing 12-month earnings basis). As stock prices have advanced higher, the P/E ratio has actually fallen due to strong corporate earnings.
- Earnings growth from corporate America has been robust since the depths of the pandemic with Q1 2021 year-on-year earnings growth at 53%.
- Three short months ago, analysts were expecting just over a 52% improvement in corporate earnings for Q2 2021 over Q2 2020 COVID-impacted levels.
- Those expectations are now materially higher at just under 63% year-over-year growth.
Price-to-earnings (P/E) is the ratio of the price of a stock (or index) to the earnings per share.
Is the Current Inflation Temporary or Persistent?
- Core CPI and the PCE deflator have spiked to levels not seen in over 30 years.
- The Fed insisting that the spike was transitory and related to temporary supply chain disruptions.
- If inflation is temporarily spiking from physical mismatches of things, a low reading from capacity utilization would be a nice confirming indicator that it’s transitory.
- The old rule of thumb is that sustained inflationary pressures only happen when capacity utilization rises above 80, as we experienced in the 1970s and 1980s.
- It is noteworthy that it has remained below 80 for nearly this entire century.
Source: 2021 ProShares Mid-Year Outlook
Fed Policy Makers Still Think Inflation is Temporary:
- The June CPI report showed reopening-sensitive categories dominating price pressures for a third straight month.
- Bloomberg estimates that 55% of the month-over-month increase came from six components — used cars, rental cars, vehicle insurance, lodging, airfares, and food away from home — up from 52% the prior month.
- Including energy prices, that proportion rises to 66%. The composition means the bulk of Fed policy makers will still subscribe to the transitory, or temporary, inflation thesis.
- What could change the Fed’s view? If pressures begin to build in labor-slack sensitive services categories.
Source: BLS, Bloomberg Economics
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