Most trends in place during the first quarter of 2021 continued during Q2 which has produced a healthy environment for risk assets. Economic activity domestically (and across most major world economies) remains strong and above long-term secular numbers. U.S. companies are still reporting primarily upside earnings surprises here in July for their second quarters. Cash flow is excellent, dividends are moving up and share buybacks, especially in the financial sectors are on the rise again as companies look for efficient ways to deploy their cash flow. Domestic stock markets are still outperforming non-U.S. markets (both emerging and developed). Domestic small and mid-cap stocks have retained their strength reflected in the second half of 2020. Bond returns have been lethargic.
With all of this contributing to an upbeat environment, the truth is that it is still hard to have a lot of conviction for anything and perhaps a bit of paranoia has set in.
Will companies continue to be able to report blowout earnings and, at the very least, upside surprises?
Will the Federal Reserve continue to pump massive amounts of money into the economy?
When will GDP growth normalize and at what level of growth?
Has the definition of capital preservation, which relied heavily on fixed income and cash, changed for the near-intermediate term?
Will the Federal Reserve really wait until employment reaches the pre-pandemic levels before giving serious consideration to raising interest rates?
Last quarter we highlighted inflation, valuations, and taxes as our key concerns. Certainly, inflation has moved higher (up 5.4% for 12-months) since we wrote this as have equity valuations. Taxes, while still a concern, seem to have taken a back seat to the infrastructure bill in Washington, D.C.
Let us throw out several other things that we find high on our list of worries:
Is everything peaking?
Q2 may prove to be the high watermark in a number of key measurements.
Is there too much complacency?
The broader stock market indices keep hitting new highs and the impact of bad or not-so-good news seems to have a very short impact and then we see a resumption of the rising stock market.
Is China’s crackdown on its technology sector something that could have implications in terms of their policies toward our tech sector?
Will we have a new Federal Reserve Chairperson when Jay Powell’s term expires in February, or will he be reappointed?
Our view – hard to see someone more hawkish than Powell in that seat.
Are we setting ourselves up for a meaningful debt ceiling debate?
Given the Biden Administration’s plans for infrastructure (traditional infrastructure) and social spending, we are looking at potentially huge spending numbers and this could provide Congress with a pretty meaningful debate on this subject and a negative impact on the U.S. dollar and our equity markets.
Are the supply chains disruption that we are seeing across many industries likely to persist?
Clearly if it does it is hard to see the impact on corporate earnings being positive.