The thermometer tells us that it is summertime, and we hope you have been able to get out and spend some time with family and friends you may not have seen for a while.
Second Quarter 2021 in Review
U.S. S&P 500 corporate earnings growth was robust in the second quarter. FactSet expects earnings growth will come in at over 60% for the quarter, which would be the highest in 10 years. The reopening is going well, and there will likely be dramatic job growth in sectors disrupted by the pandemic.
The biggest driver of growth in the first half of the year was the rapidly improving COVID landscape and its economic implications. Globally, countries are reopening at varying speeds, but the U.S. is ahead of most in this regard. The high vaccination rate in the U.S. is helping our economy reopen successfully.
Capital spending should pick up going forward. Although there are still 14,200,000 people on the various Federal & State unemployment programs, the labor market is moving toward normalization. We think a significant downside risk is a prolonged supply shortage, which would impede production, hiring growth and push up price pressure for longer than expected. During the pandemic, many global supply chains have been massively disrupted, causing shortages of all kinds, higher prices, and delays in many products and services. Companies are building new supply chains, but that will take time to accomplish.
Real GDP grew at a 6.4% annual rate in Q1 and is on track to expand at a greater than 9% annual rate in Q2. We expect real GDP to increase from 6.5% to 7% for 2021, which we have not seen in 16 years.
There is a debate whether the price increases we are experiencing should be considered inflation or are just transitory. The opinions seem to be split evenly amongst economists and market strategists. The current consensus forecast expects inflation to have peaked in Q2. This week, the BLS (Bureau of Labor Statistics) reported June CPI (Consumer Price Index, i.e. inflation) at 5.4% for the last 12 months, the highest we have seen in 10 years, and the PPI at 7.3% (Producer Price Index). CPI is expected to finish the year around 3.5%. That is down from the peak, but is still much higher than the sub 2% range we have had for the last ten years.
The Quarter Ahead
We think the 2nd half of 2021 will be more challenging. The fiscal stimulus that propelled the recovery is weakening but will still support the economy in the second half. A partial offset for some will come from new changes to the Advanced Child Tax Credit Program, which will pay between $250 - $300 per child per month, starting in July for qualifying households with incomes of up to $150,000. In addition, consumers have amassed an estimated $2 trillion in excess savings since the start of the pandemic, which should help smooth disruptions in consumer spending as government assistance diminishes.
Housing is still robust, although sales have come down from peak levels in January. Historically, housing prices have tracked closely with long-term inflation but have become overvalued at times. Low-interest rates keep home buyers active, but the average annual national price increase of 13% has made a home purchase out of reach for a growing number of potential buyers over the last year. This rate of growth is unsustainable in the longer term. The increase in home prices will also affect future rents, which are just recently beginning to rise as the economy reopens.
It is tough to find historical examples of a cycle that looks like this one. We can go back to the previous significant pandemics and see how they played out, but the policy responses this time were completely different. The most apparent difference is that vaccines were not available in previous pandemics. What also seems to be new in this cycle is the magnitude of the fiscal stimulus. We can analyze the base effects and how oil affects the CPI numbers, but the tricky part is that we have not had much experience dealing with consistent long-term fiscal stimulus. So we could have a situation where fiscal stimulus essentially ends up being a very prolonged process that impacts overall demand in the economy for a multi-year period. That is a very different setup than we have had before. It appears that, at least for 2021 and 2022, the fiscal stimulus is going to be very aggressive here in the U.S.
Historically, monetary policy has never been this accommodative. Most countries worldwide have interest rates near 0%, and there is still $13 Trillion of sovereign bonds at negative rates. Here in the U.S., the Fed is continuing its Quantitative Easing program, buying $140 billion of Treasury and mortgage bonds per month to keep interest rates low to support the recovery.
When the economy is strong enough to stand on its own, interest rates should rise to a normal level, which would be a healthy economic signal. However, there are reasons the Fed would like to keep interest rates low and has worked very hard to keep them there. It is a fine line: if rates remain artificially low, markets can get distorted, but if rates climb too high, then the recovery would stall. Possibly the worst scenario would be if rates rise too high too quickly, in which case many companies would not be able to afford the interest payments on their debt.
As government support continues, the next fiscal program in the planning stage is the infrastructure program here in the U.S. It is currently forecasted to be around $1.2 trillion to rebuild much of the country's infrastructure: roads, bridges, airports, among other things. But, of course, Washington is debating how to pay for it.
For 2021, the global growth forecast remains at 6.1%. We expect the rolling recoveries around the world to reach their peak growth in Q3. Vaccination rollouts, the easing of stringent measures, plus robust monetary and fiscal stimulus are all elements contributing to a strong recovery overseas. As life normalizes, we will likely see greater consumer demand in Europe and Japan. Valuations in developed countries are much lower than here in the U.S., in part because of their slower reopening. We think they could catch up to the U.S. over the next year or so.
China was the first economy to recover after being the first to go into lockdown when COVID was discovered. Now China's economy has been the first to peak and slow. China is slipping into "Stagflation" as growth slows and inflation rises. In addition, China has been increasing regulation and scrutiny of many of its large technology companies causing its technology sector to decline this year under the uncertainty of future policies. In a globally connected world, a slowing economy in China will have a negative impact on the global economic picture. The PBOC (the Fed equivalent in China) has refrained from significant stimulus spending as it did in 2017, which succeeded but put the country deep into debt.
Robust but decelerating growth in the second half of 2021 could cause more volatility than we have been experiencing. We maintain our allocation to the diversified basket of U.S. equities with some developed foreign and emerging market exposure in the equity allocation. In the future, we still expect the dollar to continue its gradual decline. That should provide us with good opportunities in foreign and emerging markets. We expect the U.S. markets to be positive on earnings growth through the summer.
We will continue to monitor the global economy and adjust your portfolio according to your investment strategy. If you have any questions, we would be happy to discuss them with you and share our thoughts. Thank you for your trust and confidence.
The Silicon Valley Wealth Advisors Team
Tracy Lasecke, CFP® Chris Duke, CFP® Scott Ponder, MBA, CFP®
Scott Yang, CPA, CFP® Monique Ruiz Lisa Ozaki
Personal Notes @ SVWA
Tracy and Roberta – Tracy finally got to spend some time with family, played golf, and was able to take a hike. Tracy made it out to Birmingham, Alabama, to play with the folks at the Porsche racing school. Roberta made the annual trek from Arizona to Madison, Wisconsin, to move her Mom out of the Arizona heat for the summer.
Chris and Laura- this spring, after the entire family got vaccinated, we were finally able to travel and to see family and friends that we have not seen for over a year!
Scott and Erin- are enjoying our garden in bloom and seeing family and friends we have not seen in a while. Our nephew, who just graduated from high school in Denver, CO, is staying with us for a couple of months this summer.
Scott Yang - My daughter reached a milestone and graduated from high school. My son and wife are also taking a nice break from school after a long year of online teaching and learning. We hope to take a nice vacation in 2022.
Mo and family enjoyed a weekend at a cabin in Cazadero. The family is also enjoying the tradition of having lunch with close family and friends.
Lisa Ozaki went on a trip to Sequoia National Park and hiked the Marble Falls Trail. She didn’t bring enough water, so she barely had enough on the way back when it was 95 degrees. It definitely made the trip more memorable. She also started watching a new anime, Haikyu, which is about volleyball.
Charles Tran is new to SVWA as a Financial Planning Associate. He comes from a background of working in corporate finance and made his career transition into Financial Planning back when he joined in April. He is currently working on passing his Series 65 examination and starting the CFP coursework soon.