Weekly Update

What the Bulls See

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Published July 2, 2021

Last week we brought you a global outlook from Schwab. This week, we bring a mid-year outlook published by Invesco, the company responsible for the Nasdaq 100 ETF (symbol: QQQ) that our models focus on. Needless to say, Invesco is very positive on the outlook. Here is why they are so bullish:

1. It’s early in the business cycle

Equity markets tend to lead the business cycle, and this cycle appears to have room to run. The last five elongated US business cycles lasted an average of 7 years and produced, on average, a cumulative 25% growth in US real gross domestic product (GDP). The current cycle is only one year old, and US real GDP is only just returning to where it was at the start of 2020.

2. The economy is hot

Consumer spending, business investment, and housing are all booming at the same time. Leading indicators for the global economy are approaching multi-year highs, suggesting that the economy may grow above trend for the foreseeable future.

3. A strong economy suggests companies could grow into their valuations

There’s been a lot of hand wringing about valuations, but valuations are almost always elevated one year after a recession. However, history informs us that stocks grew into their multiples after every recession since the early 1990s. Leading indicators signal that a V-shaped recovery in earnings growth could be imminent. Our research shows that stocks produced consistent double-digit returns during periods of positive earnings growth over the past 31 years, regardless of what multiples did.

4. Financial conditions are the loosest on record

Interest rates are low, the US dollar is relatively weak, corporate bond spreads are tight, and the equity market is at or near all-time highs. Admittedly that all may sound ominous to investors, but historically the time to become concerned has been when financial conditions have tightened meaningfully, and not when they are historically easy.

5. The Federal Reserve isn’t expected to raise rates until late 2022

In short, don’t fight the Fed. The process of policy normalization may be in the offing, but the Fed is unlikely to tighten policy meaningfully with the “real” unemployment rate, which includes part-time workers and those who are marginally attached to the labor force, still above 10%.

6. Historically, it’s not the first interest rate hike that tends to matter anyway

A review of past initial rate hikes in business cycles (’94, ‘04, ’15) indicates that returns remain robust in the 12 months prior to, and 36 months post, the first interest rate hike, weakening only when the US Treasury yield curve flattens.

7. The bond market believes the rate of inflation may moderate.

Short-term inflation expectations are above 3%, but 3-year and 5-year inflation expectations are around 2.5%, closer to the Fed’s perceived “comfort zone.” If accurate, then near-term inflation that’s supportive of corporate earnings, followed by moderating inflation pressure that allows the Fed to maintain policy support, feels like a very favorable backdrop for risk assets.

8. There is capacity in the economy to increase production.

Businesses are not only looking to rehire to match the growing demand but are also investing to rebuild inventories and improve productive capabilities, both of which should suppress inflation concerns. Capital expenditures are back to pre-pandemic levels. The “real” unemployment rate, which includes part-time employees and those who are only marginally attached to the labor force, stands at 10.2%, suggesting that the economy isn’t close to full employment.

9. There’s a lot of money on the sidelines.

There is $20 trillion total in cash, checking deposits, savings deposits, and other “near money.” While investors focus on goods inflation, it is reasonable to expect that “too much money, chasing too few assets” could result in asset price inflation.

10. Investors are not euphoric about equities.

It is said that market cycles tend to end in investor euphoria. Investors, since the global financial crisis, have allocated over $3 trillion into bond mutual fund and ETF strategies and over $1 trillion into money market strategies. On the other hand, investors have only allocated a cumulative $550 billion to equity strategies. It appears there’s space to go before investors appear “euphoric”.

Market Update

Stocks popped higher Monday as interest rates continued their downtrend. The slip in rates perhaps says that investors have become less concerned with inflation pressures. That change in sentiment has pushed investors back into growth stocks like tech. The tech-heavy Nasdaq 100 (QQQ) rose +1% in Monday’s trade. A rather flat day Tuesday and Wednesday with investors awaiting news from OPEC and the monthly jobs report. Thursday saw oil prices jump on OPEC’s delay of any decision regarding oil output. Stocks joined in with a +0.5% lift. A strong employment report Friday pushed stocks further upward with a +0.8% gain as investors enter the traditionally solid month of July.

Nothing but goodness for stock investors this week. Stocks have pushed higher all but one day the past two weeks. The S&P 500 (SPY) added +1.67% for the week. The Nasdaq 100 (QQQ) continued to benefit from the shift to growth stocks with a +2.63% rise. Smallcap stocks (IWM) fell back -1.33%.

Warm wishes and until next week.