Overview: Stocks around the world were mixed last week, as U.S. equities recorded new highs while international stocks fell. For the week, the S&P 500 index was up 1.7%, on the heels of higher government growth estimates and improved employment numbers. In contrast, international stocks fell, as new COVID-19 restrictions and the spread of the COVID-19 Delta variant put pressure on valuations. In bonds, the U.S. 10-year Treasury ended the week lower in yield at 1.43%. A key factor helped drive Treasury yields lower, i.e. portfolio rebalancing at quarter-end. The relative outperformance of stocks versus bonds for the quarter and year-to-date has resulted in a shift to bonds to maintain target allocations, and this has supported yields. Economic data was strong last week, as U.S. nonfarm payrolls rose 850,000 in June, above consensus and trending higher from the 559,000 May number. Initial jobless claims also showed a labor market that continues to recover. New claims fell to a lower-than-expected 364,000 in the past week, a new pandemic low.
An update on Economic Growth: (from JP Morgan) As an old proverb goes, necessity is the mother of invention, and the severity of the pandemic accelerated a technology boom that has boosted productivity. After decades of stagnant productivity growth in the U.S., we estimate that real output per worker rose by a lofty 4.1% annualized from the fourth quarter of 2019 to the second quarter of 2021. This likely reflects many of the genuine efficiencies realized by firms and consumers in the pandemic economy. Workers have trimmed their commuting times and logged in more hours, as rapid economic growth coincided with chronic labor shortages. Firms were forced to pull forward technological advancement to facilitate widespread remote work, and the pressures of the pandemic forced many businesses to rethink their operating models to become more efficient and agile. A general switch to goods consumption from services consumption likely further boosted productivity numbers. While we expect to lose some of this productivity boost as we return to our pre-pandemic routines and the consumption of services recovers, some of it could stick around, particularly in regards to continued remote work and increased automation. Whether this will be enough to spur further productivity growth in the years following the pandemic remains a question, but the level increase of productivity has been genuine and helps explain the extraordinary profit growth and at least some of the impressive stock market gains we’ve seen during the pandemic recession.
Themes for the Second Half: The biggest second-half theme for the markets in our view will be the ongoing fiscal and monetary stimulus that will continue to drive the economy. With the Federal Reserve keeping interest rates low and continuing their asset purchase program, and even more fiscal stimulus in the pipeline, the economy will surge. The obvious risk is an over-heating economy that leads to inflation.
Inflation: Long-term inflation expectations are currently well above what the bond markets are signaling. The Federal Reserve believes that inflation is temporary, and for now, markets agree, with the 10-year Treasury trading at a yield of 1.36%, well below the recent highs of 1.75% at the end of the first quarter. Last Friday’s job report showed a 3.6% year-over-year hike in hourly earnings, and wage pressures will continue as employers seek qualified workers.
The Federal Reserve: At some point, the Fed needs to taper asset purchases. The Fed balance sheet has grown 10-fold since the 2008-09 timeframe, and now is over $8 trillion in size. The current $120 billion per month asset purchase program has taken supply out of the market that will eventually (at least in part) need to be purchased by investors. The Fed’s Aug 26-28 policy meeting at Jackson Hole could be crucial, preparing the markets for tapering by year-end. Any level of tapering will act as supply to the markets that will need to be absorbed by investors.
Politics and taxes: A bipartisan group of Senators has agreed to an infrastructure bill, but there is no agreement on how to pay for the bill. In addition, other stimulus bills are in the works. The question is whether tax hikes will be needed to fund any new fiscal spending and what the ramifications will be for the markets.
Covid-19 variant: The Covid-19 Delta variant is still doing damage both domestically and on the international front. Vaccinations are lagging in some states as we strive for herd immunity to overcome the virus.
Weekly Returns and Data:
Sources: JP Morgan Asset Management, Goldman Sachs Asset Management, Barron’s, AGF Investments
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