Buoyed by an effective choice of available vaccines and an accommodative Federal Reserve, the economy appears headed toward the fastest pace of economic growth since the 1950s. This has also pushed stocks, interest rates and inflation higher.
In fact, the S&P 500 has closed higher for five consecutive months as well as has risen at least 5% for five consecutive quarters, figures that historically have boded well for future returns over the following 12-months, but have also preceded short-term volatility.
What could derail this bullish stampede? In our opinion, it would most likely be a combination of the following:
An error in the assumption currently posited by the Federal Reserve that the inflation currently percolating in the economy is transitory. The Open Market Committee of the Federal Reserve (FOMC) conveyed their position within a written statement following the most recent meeting during mid-June. “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.”
A few days later, Chair Powell appeared to recognize the recent burst of inflation, but did not seem concerned, noting that “Inflation has increased notably in recent months. This reflects, in part, the very low readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term. As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”
Danger presents itself on two fronts. The first of which is that in an effort to attract employees, any incentive offered by employers results in longer-term or secular inflation. The second is that any inflation which may start as transitory gets embedded in the expectation of consumers thereby altering the timing or quantity of purchases. Either will negatively impacted the sustainability of this economic expansion.
The second event that could derail this bull would be a resurgence of a variant of the COVID-19 virus that is immune to a vaccine. Although we are not medical professionals, play one on television or sleep at the Holiday Inn, all reports that we have read suggest that at the least in the United States, the possibility of such a breakout if not very likely.
This is as good as it gets. Backed by a massive amount of government stimulus as well as pent-up demand, the vast majority of economic data is pointing to an economic rebound, the likes of which Americans have not witnessed in over half a century. Furthermore, housebound for more than one year, Americans are willing to spend. According to the Federal Reserve, Consumer Credit rose by $35.0 billion during June and by 3.7% y/y. In addition, the labor market is rebounding, housing remains strong and interest rates are low. There is not a cloud in the sky. What if one appears as stock valuations are historically high and the S&P 500 has nearly doubled off the pandemic lows?
That’s the bear case. What do we think? We agree with Chairman Powell that inflation is transitory and once again, the disinflationary effect of technology will be the dominant force impacting prices. We also listen to Pfizer, Moderna and Johnson & Johnson, all manufacturers of the vaccine to fight COVID who seem quite certain that the impact of any variant can be contained, thereby keeping Americans healthy and the economy rolling.
Presently, the Fear Of Missing Out (FOMO) and There Is Not Alternative (TINA) support the market at least at current valuations. This environment does not appear to be coming to an end anytime soon.
Do not mistake the cautionary tone outlined above for bearishness. In fact, we feel confident in reiterating a couple of sentences from our prior newsletter. “We do appear to have a stock market that is rich in valuation on a fundamental basis and a bit extended technically which could portend a normal, garden variety pullback but nothing more.” At this time, should a pullback occur, we would consider it a buying opportunity for the longer-term.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.