Solid fundamentals should outweigh COVID-19 uncertainty

Richard Branson and Jeff Bezos haven’t been the only ones rocketing into space in recent months. Massive stimulus and economic reopening allowed US GDP growth in real terms to hit 12% year-on-year in the second quarter.

With around 4.5% inflation, this adds up to an “exospheric” 17% rate of growth in nominal terms. In the Eurozone, real year-on-year growth was 13.2%, with roughly 2% inflation over the last three months. Data suggests that growth rates will stay in orbit for a few months yet.

But in the months ahead, we can also expect a heated debate about how to navigate growth and inflation’s return from orbit.

Many commentators are concerned about stagflation, but we think these fears are overdone, and that neither COVID-19, nor central bank policy errors, nor consumer retrenchment will prompt a sharp growth slowdown.

1. The Fed remains eager to avoid alarming markets, and inflation looks unlikely to compel them to tighten prematurely.

• The release of the minutes of the Fed’s July meeting concerned markets by suggesting that officials think tapering of bond purchases could start as soon as this year, rather than January as had been thought likely. But a lot has happened in the weeks since the meeting on 27–28 July. The seven-day moving average of new cases in the US has more than doubled since the meeting, and Fed Chair Jerome Powell has said that the pandemic is “still very much with us” and continues to cast a shadow over economic activity. On the price side, the latest data indicates that key drivers of inflation—including used vehicle and airfares—started to normalize in July.

2. The delta variant of COVID-19 could delay the recovery, but not derail it.

• The continued spread of the delta variant has led to renewed restrictions in several countries. At the global level, case numbers have increased for nine consecutive weeks, according to data from Johns Hopkins University. But we are also seeing promising signs that the global vaccination drive is picking up pace again. The rate of US vaccinations is at its highest level since the end of May, led by several southern states, which are facing the worst outbreaks of the delta variant. The acceleration in Asia has been even more marked, with daily doses administered since May rising 13-fold in Japan, 22-fold in Malaysia, and 24-fold in the Philippines. Meanwhile, countries in Asia that are making progress with vaccinations have started easing restrictions. This includes Malaysia, where more than 55% of the population has had at least one dose. China is an outlier, and despite a 60% vaccination rate, it has curbed domestic travel, closed tourist sites, and partially shut the world’s third-busiest port, Zhoushan. However, this zero tolerance to infections should ensure that restrictions are relatively shortlived, and won’t lead to lasting supply disruptions that would boost global inflation.

3. Economic and earnings fundamentals look set to remain robust, even though growth momentum may be slowing.

• Data from the world’s two biggest economies has disappointed recently, with a 1.1% decline in US retail sales in June suggesting that the impact of stimulus checks may be fading, while in China, industrial production and retail sales were both weaker than anticipated. But while the second quarter may mark a peak in momentum, fundamentals—both in terms of economic growth and earnings —remain robust. Pent-up savings accumulated during the pandemic and rising household income as the labor market recovers look set to support US consumer spending as the pandemic is brought under control. On earnings, 90% of S&P 500 companies by capitalization beat 2Q earnings forecasts, by close to 20% in aggregate. In China, although the economy has cooled, policymakers have responded. After last month’s broad-based 50 basis point cut in the reserve requirement ratio, we anticipate further targeted easing and speeding up of local government bond issuance.

So, instead of a hard landing, we expect inflation to recede gradually in 2022 and growth to remain strong.

Against this backdrop, we now expect 45% growth in S&P 500 earnings in 2021 and think consensus forecasts for 2022 are likely to be revised upward by nearly 10%. As this earnings trajectory is confirmed, we expect the S&P 500 to reach 5,000 by the end of 2022.

We maintain a risk-on stance and position in stocks that should benefit from strong economic growth. We prefer Japan, financials, and energy. Click here for more on positioning for reopening and recovery.

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