July 15, 2021
The global economy is experiencing one of the strongest synchronized expansions since the 1980’s as vaccination campaigns reach a growing percentage of the population, governments ease COVID mobility restrictions, and demand for goods and services surges. This has been especially true in the US, which posted an annualized growth rate of 6.4% in the first quarter.
World stock markets have reflected this recovery, led once again by the US, which had five consecutive months of gains to close the first half of 2021 at record highs. Earnings growth has also been strong, with a record 66% of S&P 500 companies issuing positive EPS guidance for the second quarter, almost double the average of the past five years.
The reopening of economies and the quick rebound in activity that followed has also fueled inflation in many countries. In May, the US consumer price index increased by 5.0% year on year. The Federal Reserve, however, sees this inflation increase as transitory, driven by temporary supply chain disruptions and inventory depletion, and has repeatedly expressed its commitment to economic stimulus until COVID is behind us and the economy is back at full employment.
Within fixed income markets, longer maturity Treasury yields have fallen for three months after shooting higher earlier in the year. This has allowed bond markets to recoup much of their first quarter losses and suggests that the earlier spike in rates, fueled by inflation fears, may have overshot. This is likely just a pause as interest rates rise from historic lows.
Bond investors appear to have grown more confident in the Fed’s willingness to intervene to contain inflation if the economy appears in danger of overheating. Indeed, the tone of the Fed’s most recent FOMC meeting was notably more hawkish than before, inferring that tighter monetary policy is in store by late next year or early 2023.
In the meantime, investors in search of income have flocked to higher yielding sectors such as emerging market debt and US and European high yield bonds. US Treasuries also continue to attract buyers, particularly international ones, given their relatively attractive yields when compared to the deeply negative real yields on European and Japanese sovereign bonds.
With demand for US assets, strong and expectations of higher yields ahead, the US dollar soared in June.
The near-term outlook for global growth remains upbeat, with government investment in infrastructure, corporate rebuilding of inventories, and new hiring poised to follow closely on
the heels of the recent rise in consumer spending. In countries that have lagged, growth should pick up as vaccine programs reach a widening segment of the population. Falling unemployment and robust corporate profits can be expected as the wave of recovery sweeps around the world.
Such a scenario should continue to benefit equity investors as well as asset classes like real estate and commodities.
We see some threats to this outlook. An earlier-than-expected tightening of monetary policy could send shockwaves through a financial system grown accustomed to cheap money. Likewise, the accelerating spread of the COVID delta variant could jeopardize global growth. Historically high asset prices make markets more vulnerable to such concerns.
That being said, the Fed has signaled its intention to maintain a policy of economic stimulus for at least another year, while the widening availability of vaccines should help contain the rate and severity of coronavirus infections. And although asset prices are high, stretched valuations alone have rarely triggered the end of a bull market.
Longer-term, the surge in growth will inevitably ebb as the world moves beyond the recovery phase, and as higher wages and interest rates cut into profit margins.
For now, however, the economic party seems likely to continue.
That said, this has also been an extraordinarily difficult time for many people. We hope that you and your loved ones are all well and emerging from the pandemic in good spirits. Should you have any questions or concerns, we will be happy to meet with you this summer - in person, if possible.
We wish you a beautiful, safe, and healthy summer.
David, Harlan, Doug & Maria
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