Are we moving toward a more normalized environment?
Over the past week, risk assets are down across the board, even after Tuesday’s (July 20) impressive rebound, as investors are increasingly focused on the likely impact of the Delta variant on the global economy, and the idea of “peak growth”. The former is self-explanatory, and sadly, a reflection of the disparity in vaccine availability across the developed and developing world, but the latter is worth delving into a bit.
With the base effect fading from both GDP (Gross Domestic Product) and earnings growth numbers, we are moving from an environment where the headlines have been eye-popping, toward a more normalized environment, especially as stimulus winds down (about 70% of Federal unemployment recipients will lose their benefits in September), and that could take some of the steam out of the market. The Bloomberg consensus estimate of U.S. real GDP growth for 2021-2023 stood at 6.6%, 4.1%, and 2.3%, respectively, as of June 30th. And according to S&P, 2Q21 operating earnings growth will come in around 64% over 2Q20, but beginning next quarter, those growth numbers will drop off precipitously. All of which helps explain why in the face of inflation fears, the 10-year fell from a high of 1.74% at the end of March to 1.19% as of July 20th (see chart), and the Barclays US Treasury 20+ Yr is up 4.1% month to date (as of July 20th).
While GDP is expected to head back to its pre-COVID, slow growth ways in 2023, analysts are still quite bullish on the earnings environment, with double digit gains baked into 2022 and 2023 estimates.
Certainly, GDP and corporate earnings can disconnect over shorter time frames, but GDP growth is ultimately a cap on earnings growth for corporate America as a whole. Oh, and margins are at or near all-time highs just as taxes, wages, commodities and other input costs, and potentially rates/debt service are all moving higher or are poised to do so. One would think that would give analysts cause for pause.
Sell-side analysts aside, investors are discriminating a bit more in their stock picks, market breadth has dropped noticeably in recent weeks, as overall growth and the reflation trade has come under question.
And just as all these issues are playing out, individual investors’ exposure to equities is nearing the all-time high set during the Tech Bubble, as reported by the Wall Street Journal earlier this week. Keep your fingers crossed!
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Bloomberg Barclays U.S. Treasury 20+ Year
Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity.