May 25, 2021
Equity markets resumed their march to higher highs despite the recent pullback in growth stocks due to rising interest rate concerns. The 10-year Treasury yield rose to about 1.75%, causing many technology companies and other growth stocks to recede as much as 20% in previous months. The 10-year Treasury has retreated to about 1.6% and growth stocks have since rebounded. First quarter earnings are being reported and they are very strong. Standouts include the technology sector and FAAMA stocks; Facebook, Apple, Amazon, Microsoft, Alphabet (Google). Microsoft reported a 50% increase in revenue from Azure, their cloud division, along with strong performance from their other divisions. Overall, the technology sector did very well during the shutdown. One contributing factor was the movement of the labor force from the office to working from home. This required the purchase of new computers, monitors, software, printers, headsets, all needed to create home offices. Going forward, higher interest rates will put downward pressure on the technology sector and growth stocks but will also strengthen financial and value stocks. Stocks and real estate have lofty valuations based on the anticipation of increased future earnings; we expect to see some consolidation in the months ahead as stock fundamentals play catch up.
Earnings for 2021 are expected to be modestly above earnings for 2019, a pre-COVID year. The first quarter of 2021 economic snapback will result in annualized real GDP growth of around 7%, but the economy has much further to go to reach full recovery. We are focusing our efforts on earnings for the next year, 2022 and are expecting 5% growth based on current estimates. The deleveraging of the banks and individuals since the Great Recession is over. Individuals and banks have rebuilt their balance sheets and thus a major financial headwind is removed, providing credit and capital for consumer spending, loans and investment.
The ISM manufacturing index is a widely used barometer of measuring the change in the U.S. and global GDP growth momentum. Today it is at its highest levels since the early 1980s. Just as earnings collapsed sharply when the COVID shutdown went into effect, now the economy is reopening, and the earnings are posting terrific percentage gains. The ISM index will decline as the economy reaches full employment. There is a high correlation between the change in the ISM index and share prices. An elevated ISM level in the past has corresponded with subpar equity returns for the next three months to one year. This does not imply the end of a bull market, usually a pause or a correction. The tsunami of fiscal stimulus will provide substantial support for the global economy and most asset markets.
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