Second quarter is likely the peak growth rate for both the economy and corporate earnings; with positive economic surprises waning.
For now, inflation looks “transitory,” but labor market slack holds the key to whether it becomes more persistent.
Sentiment, including margin debt and CEO confidence, suggest some contrarian market risk.
I’m a “rock chick” and nearly all my written reports are titled with a rock song title … but our twice-yearly outlooks don’t leave room for that levity; so I’ll weave them in another way. Last year at this time, I was asked on a virtual event what song(s) I felt best characterized the environment in which we were living. Immediately I thought of both Gimme Shelter by The Rolling Stones and Don’t Stand So Close to Me by The Police. Today I might choose Back in the Saddle Again by Aerosmith, reflecting the fact that we are in the midst of the U.S. economy likely surpassing its pre-pandemic level as measured by gross domestic product (GDP). This is unquestionably good news; but may not mean smooth sailing for the stock market as you’ll read below.
The question as we head toward the second half of the year is whether we’re facing a long-lasting boom (aka, a new “Roaring Twenties”), a boom-settle, or a boom-bust scenario. At this point, I lean toward the boom-settle scenario; in part because we may be facing another peak in the growth rate for both the economy and corporate earnings (distinguished from peak growth). Last year at this time we were in the midst of the second quarter of 2020, when GDP contracted by -31.4 (quarter-over-quarter annualized rate). That was followed by the eye-popping initial rebound of +33.4% in the third quarter; with the fourth quarter coming in at a more tepid +4.3%.
This year’s first quarter saw growth of +6.4%, with the second quarter expected to jump to +9.4% as the economy fully opens. Bloomberg’s tracking of economists’ estimates suggests this will be followed by steadily descending, but still positive, growth rates in the subsequent two quarters (+6.8% and +4.8%, respectively). In fact, after some epically strong readings, the latest economic data has been mixed-to-weaker; including worse-than-expected readings for personal income, new and pending home sales, durable goods, consumer confidence and the Chicago Fed’s National Activity Index.
As you can see below, the Citi Economic Surprise Index—which measures how economic data is coming in relative to expectations—has come significantly off the boil relative to its peak last July. The accompanying table shows that as the index descended historically, so did annualized returns for the S&P 500.