Broad-Based Recovery Bodes Well for Stocks

As the U.S. economy continues to rebound, second-quarter earnings are coming in strong. From technology and financials to housing, steel, pharma and consumer staples, I’ve been impressed by how broad-based the recovery is. Along with earnings, companies are providing upbeat guidance for the next two quarters and into 2022. These developments factor into the question we’re all asking: Is growth at its peak?

Though GDP growth was below expectations for Q2 — 6.5% on an annualized basis versus a revised 6.3% gain in Q1 — it is still above trendline growth, with final retail sales up 7.7% and personal consumption for services up 12%. As COVID delta variant cases rise in the U.S., we will see some volatility, but given the widespread reopenings and high level of pandemic fatigue, I do not see delta having a material effect on growth.

That leaves investors with the other pressing question: Is the uptick in inflation real or transitory? The GDP report showed that core personal consumption expenditures (PCE) inflation was up a whopping 6.1%; this included a deflator not seen since 1983, according to Merion Capital. While some inflation is indeed transitory, such as commodities and used auto prices, some — namely, wages and shelter costs — are not. 

For my portfolio, I’m seeking opportunities in financials, housing, steel, pharmaceuticals and consumer staples, and maintaining focus on technology, particularly in the cloud, e-commerce, digital video and other sectors that will benefit from trends in consumer behavior. 

Economic Growth Continues 

U.S. GDP rose in Q2 in large part due to increasing PCE, as well as nonresidential fixed investment, exports, and spending by state and local governments. Total personal savings came in at $1.97 trillion in the second quarter, a massive drop from a revised $4.07 trillion in the first quarter. The pent-up household savings we’ve been discussing for months is now starting to make its way into the economy. U.S. retail sales increased in June by 0.6% versus May, far exceeding expectations.

Consumer spending, which constitutes about 70% of GDP, continues to increase as people resume shopping, traveling, eating out and seeking entertainment. Low interest rates are bolstering consumers’ ability to make big purchases on credit. Consumer confidence continues to climb: The Conference Board reported in July that its index edged up to 129.1, above expectations, from a revised 128.9 in June, despite the rise of the delta variant and inflation concerns.

Direct stimulus payments for businesses and consumers may be largely over, but the liquidity is still in the system, contributing to what is likely to be 6.6% GDP growth this year, and 4% for 2022. Bond buying by the Federal Reserve continues, and in his latest statements, Chairman Jerome Powell did not provide a date for the Fed to taper its efforts. This stimulus, plus the imminent federal infrastructure package, will continue to fuel the economy.

The surge in consumer demand and expectations for further growth have affected manufacturing: The Institute for Supply management’s June manufacturing PMI registered 60.6%, with new orders at 66.0% (above 50 indicates an expanding economy). Both showed 13 straight months of growth, while customers’ inventories remain low. 

The Philadelphia Fed Manufacturing Prices Paid Index decreased to 69.7 in July after reaching a 42-year high in June. Notably, over 72% of the firms surveyed reported higher input prices this month, while only 2% of the firms reported lower input prices.

While the Fed continues to express that inflation is transitory, I’m skeptical. What is likely transitory is higher commodities prices, as well as items affected by supply chain issues. Wages and shelter prices, however, are not. The Job Openings and Labor Turnover Survey (JOLTS), which tracks data on job openings, hires and separations, showed that job openings hit 9.2 million in May. Many companies are unable to find workers, which pushes up wages.