The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen's 2021 Q2 Outlook
- U.S. economy: A strong economic backdrop bodes well for U.S. economic growth.
- Global economy: Should also surge as large developed countries sprint into the post-pandemic world.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: Take more risk in credit-sensitive parts of the market.
- Equities: Bullish on cyclicals but looking for opportunities again in growth.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“Success isn’t about the end result. It’s about what you learn along the way.”
— Vera Wang
First-quarter earnings season keeps the upside surprises coming
With most companies having closed their books for the quarter, we can sum up overall earnings report cards in one word: stellar. S&P 500 Index constituents have reported earnings growth that beat year-ago results by over 49% on average — nearly double the expected pace coming into the quarter. Moreover, analysts’ full-year outlooks for profit expansion by U.S. companies have risen sharply since early January, from 17% to 32% growth as of May 19.3 And upward revisions to global earnings growth for the year to date now place 2021 forecasts close to their 2022 consensus at the start of the year.4 Clearly, a corporate comeback has emerged far sooner than anticipated.
We’ve had just one truly high-conviction call on equity markets in 2021: earnings will outpace total returns. Last year, corporate profits fell by over 10% but the S&P 500 finished with an 18% total return.5 In order for valuations to come back down, those figures need to at least partially reverse in 2021. We expect earnings to grow up to 40% this year but don’t anticipate that equity markets will keep up that pace despite their fast start to the year. Stock prices were able to quickly incorporate the upside surprises from the prospect of larger U.S. fiscal stimulus and faster vaccinations. Meanwhile, earnings revisions were (and always will be) slower to reflect such positive changes.
Looking a bit farther ahead, we believe both year-on-year S&P 500 earnings growth will peak in the second quarter given the favorable comparison to last year’s spring lockdowns, which weighed heavily on most businesses. In terms of the overall economy, we’re expecting the upcoming three-month period to bring the strongest quarter-on-quarter and year-over-year GDP growth this year. Outside the U.S., any earnings bump will be bumpier in markets where lockdowns have been stricter and longer-lasting. In Europe, for example, where economies are finally reopening, earnings growth is unlikely to reach its peak before late in the second half of this year.
Better-than-expected profits growth suggests a higher ceiling on stocks’ total returns in 2021. If they fall short of that ceiling, the culprit may well be concerns about higher inflation and announcements by the Federal Reserve, European Central Bank and Bank of England about potentially tapering their respective monthly quantitative easing (QE) bond-buying purchases.
Indeed, minutes from the Fed’s April meeting, released last Wednesday, revealed that a “number” of Fed officials suggested that “if the economy continued to make rapid progress” toward the Fed’s dual mandate of full employment and 2% inflation over time, then “it may be appropriate at some point…to begin discussing a plan for adjusting the pace of asset purchases.” Not exactly an urgent warning about near-term changes, as we see it. Yet in response, stocks lost over 0.5% on the mere mention of tapering, and the 10-year U.S. Treasury yield rose as much as 7 basis points (bps) before reversing the next day.
Consider that the Fed’s minutes came from a meeting held more than a week prior to the release of April’s employment report, one that showed the economy not making rapid progress toward the Fed’s goal of full employment. We believe that makes it less likely the Fed will tighten policy anytime soon. In fact, expect the Fed to err on the dovish side regarding the timing and speed of both QE tapering and interest rate increases.
The U.S. is about to hand the “peak growth” champion’s belt to Europe
Add Japan to the list of developed countries, which already included the U.K. and most of continental Europe, where economic growth was negative in the first quarter. Japan’s GDP shrank by 1.3%, driven by contractions in both consumption and investment.6
Unfortunately, unlike those other economies, Japan’s most recent data doesn’t provide optimism that a rebound is forthcoming, due in large part to a resurgence in COVID-19 cases and the reimposition of lockdown measures. The country’s preliminary composite Purchasing Managers’ Index (PMI), which tracks manufacturing and service-sector activity, fell from 51.0 in April to 48.1 in May.7 (Readings below 50 indicate contraction.)
In contrast, the eurozone’s May composite PMI boomed to a 39-month peak, fueled by rapidly expanding activity in the service sector.8 Services were especially hard-hit by pandemic-driven lockdowns and are now the leading beneficiaries as restrictions are eased.
Results from the U.K. were even better, with its April composite PMI hitting 62, the highest level in more than two decades. Last month’s retail sales growth (+9.2%) in the U.K. was also impressive, blowing away expectations (+4.5%).9 Underestimating the pace and strength of demand growth as societies reopen has been a hallmark of economic forecasting during the pandemic.
The story is a bit different, again, in China. Its government has wound down stimulus and virus data is spotty (at best). High-frequency economic releases show a clear slowdown in activity, even if the numbers still look better compared to last year. April’s increase in Chinese industrial output was the weakest since before the pandemic, while retail sales growth downshifted from healthy gains in February and March.10 China’s export growth should continue to turn up as demand surges from most of its largest customers, but its overall GDP growth rate continues to decelerate.11
All of this stands in stark contrast to the U.S., which grew 1.6% in the first quarter (6.4% annualized), and, in our view, will almost certainly peak in the second quarter at an even higher rate. Meanwhile, it appears that the U.K. and eurozone are just getting warmed up. We’re looking for growth outside the U.S. to crest in the third quarter or possibly later.
Coming into 2021, we thought the global economic recovery would be somewhat synchronous as countries vaccinated their populations and reopened at roughly the same time. Turns out that didn’t happen. Instead, a sequenced global recovery is occurring, one in which countries emerge strongly from the pandemic, but not all at once. Countries with relatively few COVID-19-related restrictions, a large percentage of people vaccinated and aggressive fiscal stimulus programs should enjoy the earliest and highest economic bounces. For now, only the U.S. checks all three of those boxes.