The U.S. economy powered forward faster than nearly anyone had expected in the first half of 2021. As we were writing our outlook for 2021 in late 2020, our economic views were significantly more optimistic than consensus forecasts — but in retrospect, not nearly optimistic enough. Our theme was getting back on the road again and powering forward. But as the economy accelerates to what may be its best year of growth in decades, power has been converted to speed and we’re trading highways for raceways.
Speed can be exhilarating, but it also can be dangerous. Traffic becomes a test of nerves. Turning a sharp corner creates added stress on drivers. Tires wear, and engines can overheat. As we look ahead to the second half of 2021, and even into 2022, we see an economy still on the move before it slowly starts to settle back into historical norms. The speed is thrilling and the overall economic picture remains sound, likely supporting strong profit growth and potential stock market gains. But the pace of reopening also creates new hazards. Supply chains are stressed, some labor shortages have emerged, inflation is heating up – at least temporarily – and asset prices look expensive compared to historical figures.
Markets are forward-looking, and in LPL Research’s Midyear Outlook 2021: Picking Up Speed, we help you keep your eyes on the road ahead. We focus on the next six to 12 months, when markets may be looking at which latecomers to the rally have the strength to extend their run, and whether there may be new beneficiaries of the global reopening. But smart investors always are looking even further ahead, beyond the next curve, next lap, or even next race. Sound financial advice remains the key to durability. So, buckle your seatbelt and tune up your portfolio. The next stretch may be a fast one with new risks to navigate, but it’s still just another step toward meeting your long-term financial goals.
Here’s where we think we are:
The country has reopened, and the growth rate of the U.S. economy may have peaked in the second quarter of 2021, but there is still plenty of momentum left to extend above-average growth into 2022. We forecast 6.25 to 6.75 percent U.S. gross domestic product (GDP) growth in 2021, which would be the best year in decades. We continue to watch inflation closely, but believe recent price pressures are transitory and will begin to work their way off gradually later in the year. The average U.S. expansion since World War II has lasted an average of five years, and much longer over the last few decades. There’s nothing on the horizon to indicate the current expansion can’t reach that mark.
The economy was supported through the pandemic by more than $5 trillion in stimulus measures and extraordinary support by the Federal Reserve (Fed). Policy will take a back seat in 2021 as private sector growth replaces stimulus checks. Tax policy, though, remains a concern. Historically higher personal tax rates have had only a modest impact on markets, but higher corporate taxes would have a direct impact on earnings growth, potentially limiting stock gains.
The second year of a bull market is often more-challenging than the first, but historically usually still produces gains. Economic improvement should continue to support S&P 500 Index earnings, which had a stunning first quarter. While valuations remain somewhat elevated, we think they look reasonable after considering still low interest rates and earnings growth potential. Our 2021 year-end S&P 500 fair-value target range of 4,400 to 4,450 is based on a price-to-earnings ratio (P/E) of 21.5 and our 2022 S&P 500 earnings per share (EPS) forecast of $205.
The second year of a bull market is often more-challenging than the first, but historically usually still produces gains. Economic improvement should continue to support S&P 500 Index earnings, which had a stunning first quarter. While valuations remain somewhat elevated, we think they look reasonable after considering still low interest rates and earnings growth potential. Our 2021 year-end S&P 500 fair-value target range of 4,400 to 4,450 is based on a price-to-earnings ratio (P/E) of 21.5 and our 2022 S&P 500 earnings per share (EPS) forecast of $205.
Inflation has been the buzzword of 2021 so far. With record fiscal stimulus, supply chain bottlenecks, semiconductor shortages, a potentially tightening labor force, and an economy nearly fully open, the threat of inflation is very real. Given the core Consumer Price Index (CPI) (excluding volatile food and energy) in May soared to its highest year-over-year change since 1992, the threat of higher inflation is no doubt real. Many worry the Fed is behind the curve and will be forced to hike rates sooner and more aggressively to prevent runaway 1970s-style inflation, though we don’t share these worries.
It makes sense that we would see historically high inflation over the summer months for the simple fact that a year ago at this time CPI was negative three months in a row during the shutdowns, elevating the year-over-year comparisons. Higher inflation will likely be “transitory” before things get back to normal later this year. Don’t forget that structural forces that kept a lid on inflation for much of the past decade are still in place. Technology, globalization, the Amazon effect, increased productivity and efficiency, automation, and high debt (which puts downward pressure on inflation) are among the major structural forces that have put the brakes on inflation for more than a decade already and will likely continue to do so.
The time to make a plan isn’t when navigating a tricky environment. We build our plans when times are easier so that we can stick with them when times are hard, or just enjoy the benefits when times are good.
We came into 2021 expecting a weaker U.S. dollar and that is what has happened, but we think many more years of weakness could be in the cards. We view the “twin deficits” of the U.S. economy – the combination of the budget deficit and the current account deficit – as a long-term structural driver that continues to put pressure on the greenback versus major global alternatives. As a historical net importer, the U.S. usually has carried a trade deficit, while the flood of pandemic aid has stretched the budget deficit and ballooned the sum of the twin deficits to all-time highs, as a percent of GDP.
The Fed has been very clear with its dovish stance for a long time, which should be another tailwind to a lower-trending dollar. The dollar also has moved in cycles that last for years. It’s currently in the midst of a lower cycle – having made major peaks in 1985, 2001, and 2017, with years of dollar weakness after the peaks – suggesting continued weaker dollar action could be ahead.
In conclusion, 2020 was a year in which planning anything seemed impossible. Having a financial plan and sticking to it was more valuable than ever. But that plan didn’t suddenly just appear. The time to make a plan isn’t when navigating a tricky environment. We build our plans when times are easier so that we can stick with them when times are hard, or just enjoy the benefits when times are good.
Looking out over the rest of 2021, it seems like the worst of the hard times are behind us. Now we’re going full-speed ahead, and we all want to take some time to enjoy the thrill after a long period of caution. These are also the times when planning is most effective – early in the economic cycle, with the next recession potentially years away, a strong start to a bull market in full gear, and a relatively calm market environment. Right now, in fact, is the ideal time to consult your financial professional on your financial goals, the most effective way to reach them, and how to be prepared for market volatility down the road.
LPL Research’s Midyear Outlook 2021: Picking Up Speed is here to help you navigate the risks and opportunities over the rest of 2021 and beyond, but your crew remains the key to progressing toward your long-term goal.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. To view the complete Midyear Outlook 2021, visit lplmycfo.com.