July 2021 | Equity Commentary
Published on August 10th, 2021
U.S. stocks continued trending higher in July, with the S&P 500 ticking about 2.4% higher. Longer duration U.S. Treasury bond yields fell during the month, which may signal the market’s expectation for moderating growth and inflation in the second half of 2021. The Bureau of Economic Analysis reported the U.S. economy grew at an annualized pace of 6.5% (“advance” estimate) in the second quarter, which while strong, still fell below the 8+% consensus estimate. The Bureau also confirmed the 2020 pandemic-induced recession officially ended in April 2020, meaning the economic downturn lasted only two months. As it were, when the recession was officially declared in June 2020, it was already over.
The U.S. economy is now back above its pre-pandemic size. Consumer spending persists as the lead driver of the expansion, with spending up 11.8% in the three months ending June 30—the second-best performance since 1952.1 Business investment also rose 8%, adding 1.1%1 to the total GDP number.
Data suggests business spending growth could persist in the second half of the year. Corporate clients of J.P. Morgan and Bank of America have nearly $1 trillion (combined) in unused credit lines, and many have been asking the banks to increase them further. J.P. Morgan recently conducted a survey of corporate clients and found 46% want to ramp-up capital spending later this year, with 38% indicating a desire to increase credit lines.2
The drag on U.S. economic growth in the second quarter came from a combination of inventory drawdowns, which subtracted 1.1% from GDP, rising imports, and a decrease in federal government spending.3 According to the Bureau of Economic Analysis, nondefense spending on intermediate goods and services fell the most, largely due to a drop-off in Paycheck Protection Program (PPP) loans.
The Covid-19 Delta variant is spreading rapidly in the United States and in many countries abroad. Case studies of India and the United Kingdom suggest the Delta wave could last a few weeks and taper off, but this disease continues to be unpredictable even for the world’s foremost scientists. With regards to equity markets, the central question is whether governments reinstate lockdowns in an effort to stem the spread. We believe that here in the U.S., the risk of another lockdown remains low.
Vaccines are universally available to U.S. adults, which makes current risk far different than in previous stages of the pandemic. Mitigation measures, such as masking and social distancing, are also widely understood and can be carried out without shutting down major parts of the economy. Corporations, state and local governments, and the federal government, are also experimenting with mandates as a means to control risk, while staying open.
For example, General Motors, Ford Motor, and Stellantis (the maker of Jeep and Dodge), have reinstated mask mandates for all factory and office workers, regardless of vaccination status. Stanley Black & Decker has done the same. Facebook, Google, and even Tyson Foods have said they would require vaccinations for their entire U.S. workforce. Louisiana has introduced indoor mask mandates, while New York City will require people to show proof of vaccination for indoor activities like dining, gyms, and events with large groups. More examples exist across the economy, but the bottom line is that as long as the vaccines remain highly effective at protecting against serious illness, there can be ways to address the ongoing crisis without shutting down.
The widely-watched infrastructure bill passed a key hurdle in July. The bill must move through a very difficult amendment process in the Senate before moving over to the House, where it will likely be met with Democratic critics and mild support from Republicans. In other words, final passage is far from assured.
Even so, it is worth summarizing key features of the proposed legislation, as winners and losers are often minted in big government spending programs:
• $110 billion for traditional infrastructure, i.e., repairing and improving roads and bridges
• $39 billion to modernize public transit, including introduction of a zero-emission bus fleet
• $66 billion for passenger freight and rail systems
• $7.5 billion for a national network of electric vehicle charging stations
• $17 billion for ports and $25 billion for airports
• $65 billion expansion of broadband Internet access
• $55 billion for clean drinking water
• $73 billion in clean energy transmission
Finally, the Labor Department reported a 5.4% (4.5% core) CPI increase in June from the previous year. The base effect still applies since the U.S. economy was heavily restricted last summer, but when compared to June 2019 inflation still rose by a stout 3%. In his July testimony to Congress, Federal Reserve Chairman Jerome Powell seemed less confident than usual: “This is a shock going through the system associated with reopening of the economy, and it has driven inflation well above 2%. And, of course, we’re not comfortable with that.”