Stocks should add to second-half gains, but there are two big concerns


The Charging Bull or Wall Street Bull is pictured in the Manhattan neighborhood of New York City on January 16, 2019.

Carlo Allegri | Reuters

Stocks are expected to rise in the second half of the year, propelled by strong earnings gains and overburdened economic growth.

Market gains, however, are not expected to be as robust as in the first half of the year, when the indices jumped double-digit and set several new all-time highs. Strategists warn that there are downside risks, although they have been warning it for some time, and the market has continued to rise.

“Strong growth, strong earnings, low interest rates, a sleepy bond market. Bond yields don’t really react to inflation news,” said Ethan Harris, head of global economic research at Bank of America. “[Fed Chairman Jerome] Powell has done a good job of calming the waves in the bond market, so it’s Goldilocks for equities. “

But there are a few risks that strategists watch out for in the second half of the year. One is the potential for choppy trading when the Fed begins to discuss slowing down its bond purchases, which would be its first step away from the easy policies put in place during the pandemic.

The timing for this is not known, but many Fed watchers expect Federal Reserve officials to begin the discussion at their Jackson Hole symposium in late August.

The second is tied to the Fed again, and it’s the fear that the hot inflation numbers might not be as fleeting as central bankers expect, but that the price hike could become a bigger issue for it. ‘economy. The concern is that higher inflation readings could speed up the Fed’s timing of interest rate hikes, currently predicted by Fed officials to begin in 2023.

September the “magic month”

Harris said the economy is set to show improvement in several months, both on the labor front and on supply shortages and bottlenecks. Job growth has been strong, but not as robust as expected, as employers complain about labor shortages.

“It’s kind of like having a free summer pass,” Harris said. “The market accepts any number, whether it’s core inflation, wages or job vacancies. September is the magic month for everyone. If it doesn’t start to happen. ‘improvement is no longer Goldilocks. “

September is when extended unemployment benefits run out for many Americans, and also when parents can be released to return to the workforce while children return to school. It is also when many workers return to their desks.

Another important factor weighing on global markets is the course of the pandemic. The spread of the delta variant is causing economic shutdowns in some parts of the world, particularly in Asia.

But the market has managed to allay the concerns. “The market doesn’t care about the variant because it is known that the more we vaccinate, the more we can cope with it,” said Peter Boockvar, chief investment strategist at Bleakley Global Advisors.

Inflation is “kryptonite”

Boockvar said the markets care a lot more about inflation and how central bankers react to it globally.

“To me inflation is kryptonite, and it’s just about whether we can get rid of kryptonite or if it’s going to be hovering around us longer than we’re used to when we see statistics. inflation hot, ”Boockvar said. “If you start to see statistics for August, September and October showing inflation is very sticky, the Fed has no choice but to slow down.”

The consumer price index rose sharply this spring and rose 5% year over year in May, the highest pace since 2008, when oil prices soared. The Fed has aimed for an average range of around 2%.

Meanwhile, stocks are climbing higher as investors forecast 40% profit growth this year and view these high inflation numbers as temporary. The economy is booming and heading into the second half of the year after expected growth of 10.4% in the second quarter, according to the CNBC / Moody’s Analytics survey of economists’ forecasts. For the year, gross domestic product is expected to grow at a rate of 7.2%.

“I think the market will be fine until the end of the year. It will be single digit market gains,” Harris said.

The S&P 500 was up 14% for the year so far on Tuesday morning. The Dow Jones rose 12.4% and the Nasdaq also registered a gain of 12.4% year-to-date. The S&P 500 was slightly higher on Tuesday at 4,296.

“Currently, we are in the top 20 in terms of best first semesters,” said Sam Stovall, CFRA’s chief investment strategist. “After such a solid first half, it’s good [in the second half] but not as good as it was. We will likely have a 50% lead on the first half gain or around 7% for the S&P 500.

“The second halves are almost all pretty good,” he said. “On average, the S&P has gained 4.5% in every second since World War II. But for the top 20, they’re up 8%.” His target for the end of the year is 4,444 for the S&P.

Harris said the market was aware the Fed was going to cancel its bond program. As part of this quantitative easing program, it is buying $ 120 billion per month in treasury bills and mortgage securities. Once the gradual reduction in purchases is over, the way is clear for the Fed to raise interest rates.

“What’s really going to worry the market is that if the evidence accumulates, there is more sustained inflation. Then the Fed can talk whatever it wants, but everyone knows they will have to. start moving as soon as possible, ”said Harris. “It’s no different from any business cycle. What puts the economy in trouble and the stock market in trouble is inflation. It happens very early in the cycle.”

Until now, companies have been able to pass their higher costs on to customers, but when that is no longer possible, investors worry about pressure on margins and declining profits.

“We’re not worried that inflation is getting stuck. I’m a little surprised we haven’t had more volatility because we’ve had these higher inflation readings,” said Scott Wren, senior global strategist. at the Wells Fargo Investment Institute. “If you look at the 10 year yield, if you look at where the market is, in my mind the market is not buying into a long term inflation problem.”

The benchmark 10-year Treasury index fell 1.48% on Tuesday, far from its March and April highs of close to 1.75%. Yields move in the opposite direction, so investors bought bonds and stocks in tandem.

“We are looking at around 4,500 (S&P 500) as the midpoint of our target range for the end of the year,” Wren said. “We are a little surprised that we haven’t seen a correction … The market is quite convinced that this inflation will not be something to take hold.”

Even if the Fed is about to slow down its bond purchases, the stock market may still rise.

“I think the pressures are increasing internally. I think about half of the committee is ready to take action while Powell and his closest allies are trying to postpone that launch date as long as possible,” he said. Harris said. “I think from a market point of view, that’s not really the Fed’s big risk. Everyone knows they have to go down at some point… The big story is that the Fed will end up raising rates. of interest. “

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