STOCKS AND EARNINGS REBOUND WITH REOPENINGS
U.S. stocks returned 8.23% in the quarter adding to the exceptional rebound in stocks since the pandemic lows in March of 2020. U.S. stocks have returned 15.10% in the first half of 2021 and 44.2% in the past twelve months. Foreign stocks have also delivered strong returns, up 5.5% in the quarter and 9.2% year to date. The simplest explanation for the strong stock performance is company earnings are stronger than expected. At the onset of the pandemic, earnings estimates were slashed as economic activity came to halt. Companies cut costs to offset expected revenue pressures. Fast forward twelve months, demand has returned faster than expected and companies are benefitting as revenue growth outpaces costs increases. Amazingly, 2021 earnings estimates are now higher than prior to the pandemic and expected to increase 40% over 2020. Earnings growth is expected to slow in 2022 to 11%.
INFLATION ON THE MOVE
Inflation on nearly any measure is up 3% to 5%, depending on the measure. Current inflation rates are well above the levels seen over the past ten years. The challenge is determining how much of the acceleration is transitory. Is inflation up primarily from easy comparisons to the depressed levels in the lockdown? As an example, gas prices were depressed from reduced demand as workers and consumers stayed home. As the economy reopens, demand returns driving prices higher. The Federal Reserve believe most of the inflation pressures are transitory or base effects. The bond market seems to agree for now. However, a potential risk to stock and bond prices is the Federal Reserve having to raise rates faster than expected to combat higher inflation.
While interest rates and bond yields have increased this year, the U.S. 10 year Treasury yield is still below expected near-term inflation, 3 to 4%, and medium to long-term inflation expectations of 2 to 3%. Bond returns for 2021 are negative, down 1% year to date. Interest rates changes and bond returns are negatively correlated. Increasing rates tend to pressure bond prices while decreasing rates tend to support bond prices. While inflation pressures are weighing on bond returns, price inflation in stocks and real estate have helped offset these pressures. For most households, homes are the biggest asset on the family balance sheet. With real estate prices up 30-40% in the past twelve months, inflation has been a benefit and real estate has served as a partial hedge.
Stocks and real estate prices are up 30-50% in the past twelve months. U.S. stocks have returned nearly 20% annually in the past three years and 18% annually in the past five years. Home prices in some high demand markets has doubled in just two years. These rates of appreciation are certainly well above both historical returns and expected future returns. Fortunately, stock valuations are not stretched uniformly. Certain sectors and geographies have lagged providing opportunities to help protect on the downside and capture attractive risk and reward situations. But it is important to recognize that absent sustainable long-term earnings growth above 10%, stock returns are likely to moderate. For clients willing to accelerate their schedules to downsize or relocate, the residential real estate market is mirroring the price levels of 2008-2009. It is a seller’s market. In both good markets and bad, keeping perspective is critical.
The information contained in this material is based on sources believed to be true and reliable; however, its accuracy is not guaranteed. This material should not be construed as a recommendation to buy or sell specific securities. Views are based on market conditions, economic data, and other information at the time of publication and are subject to change.