ECONOMIC OUTLOOK REPORT – 2Q-2021
Dreher Investment Services, Inc.
April, 16 2021
A Quick Review of 1Q-2021 Markets
Financial markets continued to rally in the 1st quarter, with the S&P Index posting a +4.38% return. Markets are trading forward on a combination of the optimism of the beginning stages of a post-pandemic environment and improving economic backdrop. The short end of the interest rate curve has remained somewhat stable, with the Fed emphasizing its commitment to leave over-night rates low for the foreseeable future. Investors made their mark on the long end of the curve, halting buying which led to a sharp steepening. The 10-Year U.S. T-Note made a drastic move during the quarter, climbing from 0.92% to 1.67%.
Investors seem to be enjoying excess savings due to multiple rounds of fiscal stimulus. Increased deficit spending primarily on a new potential infrastructure bill, a successful vaccine and euphoria around the end of the pandemic have changed investors’ outlook on the markets to the upside. Once the re-opening is in full swing, domestic and geopolitical policies will likely become the focus of investors for the duration of the year.
2Q-2021 Economic Outlook
From a fundamental standpoint, the U.S. economy has continued its recovery:
- U.S. GDP – GDP increased 4.3% in the 4th quarter, beating consensus expectations of 4.1%. In an ordinary setting, this number would be considered stellar, but even with strong 4th quarter growth on the back of the record setting 33.4% growth seen in 3rd quarter, the 2020 pandemic economy saw GDP shrink -3.5% for the year. Initial 1Q-21 GDP estimates show a continued recovery, with the Atlanta Fed predicting 6% growth and the blue-chip consensus above 4%. After seeing a contraction in GDP for 2020, investors will want to see continued recovery in 2021 with the hope that long-term GDP growth numbers will approach the 3% norm.
- Employment and Wage Growth – March posted a +916,000 rise in nonfarm payrolls coming in well over the +660,000 expectation. Upward revisions of +67,000 for January and +89,000 for February further show that employment recovery is well under way. The unemployment rate is now at 6%, falling two tenths from the 6.2% rate seen in February. U.S. employment numbers have not recovered to pre-pandemic levels, but the trend is currently upward with a possible economic boom on the horizon.
- Corporate Earnings – Corporate financials showed continued signs of recovery with actual numbers and future estimates chipping away at losses seen in early 2020. S&P 500 companies reported final 4Q-20 earnings of +3.8% on the back of a +2.7% increase in revenues. Initial estimates for 1Q-21 show approximations of a +24.2% increase in earnings with a +8.5% gain in revenues. Future estimates show strong restoration in earnings and revenues through year-end.
- Inflation – March CPI rose +0.6%, bringing core CPI for the year to +2.6%. The boost to inflation mainly stems from a return to somewhat normal energy prices from what we saw this time last year. In fact, core CPI (excluding food and energy) only posted a +1.6% The Fed has acknowledged that they expected higher than normal short-term inflation numbers during the recovery and have accepted that a 2% average is more important than a 2% ceiling.
Other relevant topics that bear scrutiny:
Covid-19 – After surging in the winter months, the U.S has begun to make considerable progress against the pandemic. New cases and fatalities continue to decline as immunizations pick up. Assuming that this accelerated pace of inoculations continues, growing immunity, along with better testing and therapeutic drugs, the number of cases and fatalities should continue to drop precipitously over the summer. The possibility of life returning to a somewhat normal state later this year might become a reality.
Capitol Hill – The high cost of accommodative monetary policy, rescue programs and fiscal stimulus has raised concerns with some investors. The argument is growing louder between those who believe big spending is the solution for what ails the economy versus those who see the flood of stimulus becoming a potential burden for years to come. Rising political tensions in Washington and globally will likely gain momentum in the months ahead.
The fundamental backdrop continues to improve as the U.S. economy reopens. Unprecedented fiscal and monetary policies coupled with the increased pace of vaccinations have boded well for investors. The extraordinary debt burden for companies and governments coming out of the pandemic could prove troublesome down the road.
STRATEGIC MARKET OUTLOOK
The U.S. equity markets set all-time highs multiple times during 1Q-21, starting the year out on a positive note. Markets have climbed considerable walls of worry made up of COVID-19 risk, troubled logistics in the initial vaccine rollout and continued virus spikes. Washington will likely be in the spotlight for most of the year as the new administration gets underway. Volatility can be expected in the short-term and will continue to be used as buying opportunities to establish long-term positions.
U.S. fixed income levels the U.S 10 Year Treasury rose by more than 80% during the quarter, finishing at 1.74%. This dramatic increase in rates was based mainly on inflation fears from the fiscal spending spree. Most economists’ opinions on future inflation greatly differ from retail investors. Projections from economists see continued subdued inflation for the foreseeable future. Due to the dramatic move up in rates, we will likely start slowly working in any long-term positions for the time being.