Strong earnings growth and super-charged economic expansion are driving stocks higher.
However, the market’s gains aren’t expected to be as strong as in the first half of 2016, when indexes rose by double digits and reached multiple all-time highs. Although strategists warn of the possibility of a pullback, they have been warning about it for some time and the market has continued its upward momentum.
“Strong growth and strong earnings are combined with low interest rates to create a bond market that has been put to sleep. Ethan Harris, Head of Global Economic Research at Bank of America, stated that the bond yields don’t react to inflation news. “[Fed Chairman Jerome] Powell did a great job of calming the waves in bond markets, so this is Goldilocks with equities.
There are some risks that strategists need to be aware of in the second half of the year. One risk is that trading could become choppy when the Fed starts to talk about slowing down its bond purchases. This would be the Fed’s first move away from its easy policies during the pandemic.
Although the exact timeframe is unknown, Fed watchers anticipate that Federal Reserve officials will begin discussing this at the Jackson Hole symposium in August.
This second concern is also Fed-related. It is the fear that inflation readings that are too high may not be as short-term as central bankers anticipate. However, rising prices could pose a greater problem for the economy. Higher inflation readings could increase the Fed’s timeframe for interest rate increases, which are currently expected to begin in 2023 as per Fed officials.
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September is the “magic month”
Harris stated that the economy must show improvement in the next few months on both the labor front as well as on supply shortages. Although job growth was strong, it has not been as robust as employers expected.
Harris stated that it’s almost like having a summer pass. Harris said that the market will accept any number, regardless of whether it’s core inflation, wage growth or job openings. September is the magical month for everyone. It doesn’t get better if it doesn’t.
September is the end of extended unemployment benefits for many Americans. Parents may also be able to return to work as their children return to school in September. Many workers also return to work in September.
The pandemic is another important factor that will impact global markets. Economic shutdowns are being caused by the spread of the delta variant, especially in Asia.
The market was able to ignore concerns. Peter Boockvar (chief investment strategist at Bleakley Global Advisors) stated that the market doesn’t care much about the variant. “The more we vaccinate the better we can deal with it,” he said.
Inflation is “kryptonite”
Boockvar stated that markets are more concerned about inflation than how central banks respond globally.
Boockvar stated, “Inflation is to me kryptonite. It’s only a matter of whether or not we can kick it away or if it will be hovering around our heads longer than we’re used to seeing hot inflation stats.” The Fed cannot afford to stop tapering if you see inflation stats for August, September, and October that are very sticky.
The Consumer Price Index rose sharply in spring and was up 5% year over year in May. This is the fastest pace since 2008, when oil prices were soaring. The Fed has set an average range of 2% as its goal.
Stocks are rising as investors expect 40% profit growth this year, and consider the elevated inflation numbers temporary. According to the CNBC/Moody’s Analytics survey, economists’ forecasts, the economy is on the rise and will continue to grow in the second half. Gross domestic product will grow by 7.2% for the year.
“I believe the market will be fine until the end of this year. Harris stated that market gains will be in the single digits.
As of Tuesday morning, the S&P500 had risen 14.% so far in the year. The Dow was up 12.4% and the Nasdaq had a 12.4% increase year-to-date. The S&P 500 was slightly higher at 4,296 Tuesday.
According to Sam Stovall (Chairman of Investment Strategy at CFRA), “Right now, we are in top 20 in terms best first halves.” It’s great [in the second halves] because of such strong first halves but not as much as it was. The S&P 500 will see a gain of about 7% or 50% over the first half.
He said that second halves were almost all “pretty good”. The S&P has seen an average 4.5% increase in second halves since World War II. They’re up 8% for the top 20.” His yearend target for the S&P is 4,444.
Harris stated that the market knows the Fed is ending its bond program. It is currently purchasing $120 billion per month in Treasurys, mortgage securities and other quantitative easing programs. After it has tapered back its purchases slowly, the Fed can raise interest rates.
The evidence of more sustained inflation will be what really concerns the market. Harris said that while the Fed could talk all they want, everyone knows that they have to get moving sooner than later. This isn’t any different from any other business cycle. Inflation is what causes trouble in the economy and equity markets. It’s only a very early stage of the cycle.
Companies have so far been able to pass on higher costs to customers. Investors would be concerned about weaker profits and margin pressures if that was not possible.
“We don’t worry about inflation becoming embedded. Scott Wren, the senior global strategist at Wells Fargo Investment Institute, said that it is a surprise that we haven’t experienced more volatility since we had higher inflation readings. “If you look at the 10-year yield and where the market stands, I believe the market doesn’t buy into long-term inflation problems.
Tuesday’s benchmark 10-year Treasury yielded 1.48%, which is well below its March and April highs of 1.75%. Investors have been purchasing stocks and bonds in tandem, as yields are opposite to price.
Wren stated that the midpoint of our target range at the end of this year is 4,500 (S&P 500). “We are a bit surprised that we haven’t seen a correction… The market is pretty sure that this inflation will not become embedded.”
The stock market can still rise despite the Fed slowing down its bond purchases.
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“I believe the internal pressures are increasing. Harris stated that about half of the committee is eager to move on this, while Powell and his closest comrades are trying to delay the launch date as long as possible. From a market perspective, I think this is not the biggest risk from the Fed. Everyone knows that they will have to taper… The big story is that the Fed will eventually raise interest rates.