Overview: Stocks were higher around the world last week, led by a bipartisan agreement in the U.S. on a revised infrastructure package. As currently proposed, the plan will inject $1.2 trillion into infrastructure over eight years. Spending would include $312 billion for transportation projects, $65 billion for broadband services, and $55 billion for waterways. The S&P 500 index posted its largest weekly gain since February, up 2.8%. International developed and emerging market stocks followed suit, up 1.5% and 1.4% respectively. In bonds, interest rates moved higher for the week, but remain trading in a narrow range, with the 10-year Treasury ending the week at 1.53%. In commodities, oil prices neared a three-year high following energy demand optimism and tighter supply. WTI crude oil finished the week at $74.05/barrel, up more than 50% year-to-date.
Economic news: The U.S. purchasing manager’s index (PMI) rose to a record high of 62.6 as domestic economic activity continued to expand. As the economy recovers, investors continue to monitor inflation. To wit, the latest May core PCE number came in at 3.4%, above the Fed long-term target of 2%. Over the past three decades, U.S. core inflation have remained low and relatively stable. Recent price pressure stemming from economic reopening and recovery has increased inflation in the short run. History shows that even in low inflation regimes, episodes of higher inflation has occurred and proved transitory. Whether inflation is transitory (temporary) or structural (longer-lasting) will be a key factor to monitor in the months ahead.
A note on earnings: (from JP Morgan) Since the onset of the pandemic, earnings have surprised to the upside by a significant margin. While analyst estimates are typically reliable, it seems likely that many models grossly underestimated the strength and pace of the economic recovery, leading to earnings projections that were overly pessimistic. That being said, with the 2Q21 earnings season approaching, we believe that earnings will come in well above current estimates, and are forecasting an earnings surprise of 14.6% for the S&P 500. This would represent a decline from the 23.7% surprise observed in 1Q21, but would still be above the long-run average of 7%. Going forward, earnings growth will hinge on the resiliency of profit margins. Revenue growth should remain robust through year-end, but at the same time, companies will continue to be faced with cost increases due to supply chain disruptions and higher wages. If firms can defend margins by increasing prices, inflation may move higher, pushing the Federal Reserve to pull forward its plans for tightening and potentially weighing on earnings growth. However, if firms find that demand is elastic and price increases lower revenues, they will need to find alternative levers to preserve profits. The bottom line is that earnings growth seems likely to slow as we approach 2022, but this does not seem to be reflected in analyst estimates. This suggests that estimates may need to decline if a trend of elevated surprises is to continue.
Weekly Returns and Data:
Sources: JP Morgan Asset Management, Goldman Sachs Asset Management, Barron’s
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