Shifting Gears
Supply line issues appear to be waning earlier than we thought; therefore, we are raising our forecasts for economic growth and earnings for the remainder of 2021 and 2022. Our market outlook remains favorable as coronavirus cases and deaths continue to decline while vaccinations increase dramatically worldwide; monetary bodies maintain their overly accommodative stances at least through mid-`2022, and additional fiscal stimulus is expected both here and abroad. Liquidity trends will remain unusually favorable at least through mid-2022 supporting risk assets… stocks, bonds, and hard assets. The yield curve will steepen as economic activity picks up steam but not as quickly as we initially envisioned as financial institutions, corporations, and individuals are awash with excess liquidity searching for yield. Remember, rates are still negative in Europe and Japan. Finally, we remain confident that inflation will calm back down as shortages end, supply line issues are alleviated, additional capacity comes on stream, global competition increases, higher productivity kicks in, and disruptors continue to pop up in more and more areas.
News on getting our arms around the coronavirus gets better each week as the global number of cases/deaths continue to decline; vaccinations worldwide are increasing significantly with over 1.78 billion shots given to date; 291 million doses have been given in the U.S such that we will reach herd immunity before the end of the summer; openings are accelerating in the U.S and the Eurozone, and finally, billions of doses will be available next year if needed. We remain confident that the coronavirus will be in the rearview mirror as we enter 2022, giving us confidence in the sustainability of a synchronous global economic expansion we have not seen in years.
The Fed is entering a quiet period when no governors speak as it is within two weeks of the next Fed meeting. The message from all Fed governors is consistent with Chairman Powell’s view that the recovery is ahead of expectations; inflation will run hot over the next few months due to shortages, supply line issues, and year over year comparisons, but it will subside down the road for reasons discussed before. Any policy change will be data-driven and will be communicated well before any policy change occurs. Since the economy is shifting gears earlier than we previously thought, we now feel that the Fed will share with us in the fall that a policy change is on the horizon. We expect them to begin tapering early in 2022 by reducing their monthly purchases to $80 billion. A few months later, reduced to $40 billion, if supported by the data points, and then ending all bond purchases by the summer of 2022. The Fed may decide to emphasize buying longer-dated bonds as they reduce their monthly purchases to suppress the long end of the curve. We do not expect them to hike the federal funds rate until later in 2022 if the economy is on a firm footing, which is good news. It is interesting to note that with all the recent robust economic data, the yield curve has not steepened much over the last few months, and inflationary expectations have come down. Maybe the Fed is correct, and higher inflation near term is just transitory. We agree!
Negotiations on a trillion-dollar infrastructure bill have picked up steam as the President revised his initial plan down to $1.7 trillion while the Republicans lifted their proposal to $928 billion. We continue to believe that the moderate Democrats hold the key to the final deal, which we still believe will come in closer to $1.4 trillion spent over eight years financed with a boost in the corporate tax rate to 25%, user fees, project financing, increased collections and use of money already allocated for stimulus. It is interesting to note that the Senate passed a $195 billion bill last week to bolster competitiveness with China. The legislation supports research in many areas, including manufacturing, semis, and bringing back the supply lines for essential materials to America. Finally, Biden’s administration proposed a $6 trillion budget which would take spending to record levels while running deficits above $1.3 trillion through the next decade. It projects that the debt would begin to shrink in 2030. Yeah? It is our opinion that the Dems are running a massive risk in next year’s election supporting a far-left social agenda without real fiscal discipline. Regardless, we will have stimulative budgetary policies for years to come that will bolster secular economic growth on top of the cyclical recovery as we put the coronavirus in the rearview mirror.
Domestic economic data points continue to be off the charts as we start to put the coronavirus in the rearview mirror: unemployment claims fell to a new post-pandemic low of 406,000; core capital goods orders rose 2.3%, the most in a year; the house price index increased 1.4% and is up nearly 14% over the last year(consider wealth effect); the Richmond Fed survey hit a multiyear high; consumer confidence index was a robust 117.2; assessment of current conditions increased to 144.4; durable goods orders ex-transportation rose 1.0%, shipments increased 0.6%, and unfilled orders were up 0.2%; the Chicago PMI was a robust 75.2 up from 72.1 last month; PCE increased 0.5% while the PCE price index rose 0.7% and is up 3.1% over the previous year excluding food and energy. First-quarter earnings reports are ending and were nothing short of sensational, with over 85% of companies reporting beating prior estimates while increasing their forecasts for 2021. Many companies increased their dividends and initiated stock buybacks once again too. Our margin thesis is alive and well. We continue to forecast an increase in the operating margin above 12% in 2021 and over 12.5% in 2022, up over 100 basis points from levels achieved in 2019 before the pandemic. S & P earnings may hit $200/per share in 2021 and over $215/share in 2022, up from $140/share in 2020 and $163/share in 2019. We have raised our forecasts as shortages decrease, so we lifted our second half 2021 forecasts accordingly. For instance, GM is restarting four plants next week, and MMM mentioned that supply line issues would be ending as they enter the third quarter, six months earlier than previously forecasted. All good news!
Economic data is improving overseas, too, as the coronavirus comes under control. Demand for goods and services in the Eurozone is growing at the sharpest rate in 15 years, as evidenced by an increase in the May PMI composite to 56.9, with the new orders index rising to 58.4. Companies are struggling to keep up with demand to a level not seen in over 20 years. This supports our thesis to emphasize investments in producers as they benefit from the imbalances between supply and demand, which gives them pricing power. We think China’s effort to reduce purchases of commodities, hoping to pressure pricing, may backfire on them as worldwide demand increases while supply is limited. China may end up pushing prices higher beyond current levels as their inventories drop too much while their demand increases too.
Investment Conclusion
While volatility has continued to increase over the last few weeks, we are gaining more confidence in our overall investment thesis: the coronavirus is coming under control; monetary authorities worldwide will remain overly accommodative for at least another year; excess liquidity trends will exist for at least another year favoring risk assets; inflationary pressures will decrease as additional capacity comes online and supply lines are improved; additional fiscal stimulus is coming which will only add to the cyclical recovery; operating margins are in a secular uptrend as productivity gains accelerate; inventories are woefully low which favors producers; higher dividends and buybacks are on the horizon, and we see a shift in the political winds in 2022 away from the far left.
We continue to invest where both cyclical and secular winds are on our backs. We have increased our near-term outlook as we see shortages abating earlier than anticipated as additional capacity comes online sooner while supply lines improve. Areas of emphasis include global industrials, machinery, and capital goods companies; industrial and agricultural commodities; financials; transportation; technology at a fair price; and special situations. Continue to avoid bonds, SPACs, and highfliers.
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Remember to review all the facts; pause, reflect, and consider mindset shifts; look at your asset mix with risk controls; turn off cable news; do independent research and…
Invest Accordingly!
Bill Ehrman
Paix et Prosperite LLC
917-951-4139