The stock market’s recent behavior has been nothing less than spectacular and one for the record books.
The market rebound that got underway in March last year still continues, with the major indexes at or near record levels. Helping the stock market’s momentum is optimism about the economy, with the latest economic reading showing the U.S. economy growing at +6.5% in Q2.
But there are those with less optimism about the outlook given the ongoing resurgence in infection levels and slow-moving vaccination efforts in many parts of the world that are allowing new strains of the virus to take hold. There are worries about inflation as well, with a vocal segment of the market disagreeing with the Fed’s ‘inflation-pressures-are-transitory’ outlook.
The interplay of these competing views will determine how the market performs in the coming months and quarters. To that end, let’s examine the landscape of bullish and bearish arguments to help you make up your own mind.
Let's talk about the Bull case first.
An Accelerating Recovery: The U.S. economy has now fully recouped the Covid losses and is now bigger than its last pre-pandemic reading at the end of 2019. This is a notable achievement as large slices of the economy, primarily in the leisure and hospitality space, have still not fully recovered.
Thanks to an unprecedented fiscal response since the start of the pandemic, U.S. households remain in excellent financial health. This should help keep consumer spending at elevated levels, with the recent launch of a new round of monthly government checks to families with children adding to the trend going forward.
All of this adds up to an impressive economic growth momentum, with the U.S. economy expected to expand north of +6.5% this year and close to +4% next year. These projections do not include the infrastructure spending plan that is currently being negotiated in Congress.
All in all, the growth outlook hasn’t looked this good in a long while.
Continued . . .
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1) This small-cap’s +630% growth in one year outpaced its booming industry nearly 8X over. Thousands of products and soaring revenue portend a continuing growth explosion.
2) Scandal involving a key officer had nothing to do with an exciting disease therapy that has rolled to Phase 2 trials. Looking for a massive turnaround.
3) Semiconductor company has a backload of orders, a huge divergence of price and earnings, and a roadmap for expansion.
4) Restaurant’s earnings growth rate is predicted to more than double this year. Locations and retail sales are multiplying. Stock’s up too, but not nearly in line with the rampant growth.
5) Homebuilding is on fire, but where to invest? One strong stock pulled back a little. Time to get aboard. Sales prices and volume up, costs down = more profits for investors.
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Unprecedented Policy Response: The Biden administration’s infrastructure plan has not been passed yet, but it is another sign of the extraordinary fiscal measures that have been in place since the start of the pandemic.
Beyond the visible fiscal relief measures, the government’s proactive vaccine investments, under the current and previous administrations, allowed the economy to reopen and successfully handle the Delta variant that remains a problem in many parts of the world. The absence of spectators at Olympic venues in Japan provides a clear reminder that even many rich countries don’t enjoy the vaccine abundance that we take for granted.
These policy measures helped replace lost wages for workers, assisted small businesses in staying open and staved off solvency issues in industries hit hard by the pandemic.
Supportive Fed: The Fed’s pandemic response, ranging from regulatory support to the financial system to a large QE program, has been very impressive.
The unprecedented liquidity injection in the system helped boost all asset prices and kept the housing market humming.
While there is some uncertainty in the market about the central bank’s tactical decisions as it initiates ‘tapering’ the current QE program, the market has a roadmap in the way the Fed concluded its last bond-purchase program in 2014. The Fed’s ‘transitory’ inflation explanation assures that it will be deliberate and patient as it handles this key part of its mandate.
What this means is that the Fed will continue to keep interest rates and overall financial conditions supportive of stocks for the foreseeable future.
Let's see what the Bears have to say in response.
Market Complacency about Economic Recovery: The U.S. economy has enjoyed a strong rebound, as Thursday’s +6.5% Q2 GDP growth rate shows, with estimates of much higher growth in Q3. But it is hard to sustain that level of growth without stoking inflationary pressures.
The expectation that the strong savings rate will result in above-trend consumer spending in the coming periods. The counter argument to this seemingly reasonable view relies on historical evidence that suggests only a portion of the savings will get spent, with the rest going towards burnishing households’ balance sheets.
Estimates of economic growth for the coming periods will need to come down meaningfully if this counter view of consumer spending comes to fruition.
Beyond the U.S., the outlook for the global economy is a function of Covid vaccines that remain in short supply. Vaccine shortages are primarily a developing world issue, but even a rich country like Japan is struggling with it. We should keep in mind that the U.S. vaccination effort is among the most successful ones globally, with most parts of the world way behind in vaccinating their populations.
A Durable Hit to Confidence? The risk to human life, a function of the highly contagious pathogen, has been a unique aspect of this economic downturn. As a result, previously benign activities like eating out or taking a flight or any activity that involved physical interaction with others got weaponized.
Public health officials keep emphasizing that the Covid vaccines provide sufficient immunity against Delta and other variants. This should help sustain the momentum towards increased reopening and social interactions that has started to become the norm this Summer in the U.S.
That said, the pathogen has a wide pool of unvaccinated population globally where it can thrive and morph into even deadlier variants. With the new vaccine technology, one would expect a quicker turnaround from the industry to counter any new strain that offers significant challenges to the existing vaccines. But the emergence of any such new strains will nevertheless be a hit to confidence that will have consequences for the markets.
The Market’s Fed Addiction: The market’s Fed dependence has only increased as a result of this pandemic. The central bank not only cut interest rates to near-zero, but has been playing an active role in ensuring market liquidity and backstopping corporate balance sheets.
In an ideal world, the central bank will gradually remove the market’s ‘training wheels’ without creating uncertainty and volatility. But we know that we don’t live in an ideal world, which guarantees the coming period of monetary policy transition to generate uncertainty.
The markets responded calmly to the Fed announcement on July 28th that opens the door for a ‘taper’ decision in one of the coming meetings this year. It is possible that the Fed seamlessly executes this policy change without any disturbance, but the more likely outcome is at least some level of uncertainty that disturbs the markets.
Where Do I Stand?
I don’t dismiss the bearish arguments entirely, but I don’t see them adding up to coming in the way of the U.S. economy’s rebound or reversing the spectacular rally in the market.
With most of the U.S. at-risk population already vaccinated, the risks posed by the Delta variant should be manageable and offer no durable hindrance to economic reopening.
The issue is with regions beyond the U.S. that have far smaller proportions of their populations immunized and are forced to institute fresh restrictions in the face of this outbreak. That said, the worst of the pandemic’s economic and corporate earnings impact is now behind us, with the picture getting clearer as we move forward.
As regular readers of my earnings commentary know, the earnings picture has not been this good in a long time, with estimates for the current and coming quarters steadily going up. This is a trend that I strongly feel will only accelerate in the coming months as we put the pandemic behind us.
Markets are forward-looking pricing mechanisms; they have already discounted the economic rebound and are looking forward to the aforementioned turnaround in earnings outlook. Continued confirmation of this favorable trend will further strengthen bullish sentiment in the market.
These are historic times for the economy and the market. And historic times create historic opportunities.
All in all, this is the best time to be fully invested in the market, particularly if you are investing for the long haul.
And I would definitely be a buyer on any dip because with economic growth this year and next to be the strongest in years, it looks like there's a lot more upside to go.
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Stock #1: +630% in One Year. And That’s the Beginning
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Stock #2: Scandal - But What an Opportunity for Investors!
The misstep by a key officer had nothing to do with an exciting disease therapy that has rolled to Phase 2 trials. The stock dropped, but all is normalized and we’re looking for a massive turnaround.
Stock #3: Semiconductor Company Gearing to Fill Orders
What could be better than a small, well-run company from an industry in gigantic demand? It has a backload of orders, a huge divergence of price and earnings, and a roadmap for expansion.
Stock #4: Restaurant Booms Beyond Even Pre-Pandemic Levels
Earnings growth rate is predicted to more than double this year. 25-30 new locations are planned. Retail sales are multiplying. Stock price is rising, but not yet nearly in line with the rampant growth.
Stock #5: No Better Time for Building Profits
Homebuilding is on fire, but which stock to invest in? One of the strongest pulled back a little as of late, and now it’s prime time to get aboard. Sales prices and volume up, costs down = more profits for investors.
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Thanks and good trading,
Sheraz Mian serves as the Director of Research and manages the entire research department. He also manages the Zacks Focus List and Zacks Top 10 Stocks portfolios. He invites you to access Zacks Investor Collection.
¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.