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The Economy and the Markets | Second Quarter 2021

Key takeaways

  • Easy financial conditions, generous government spending, and lofty markets appear to be providing the setup for strong growth.
  • Policymakers are staying the course, seeking broad benefits from a vigorous expansion.
  • Investors remain sanguine despite expectations for growth and inflation that are well above trend.

Setup for strongest economic growth in 35 years

Easy financial conditions, generous government spending, and strong markets have left consumers - and companies - feeling flush. We believe this provides the setup for the strongest economic growth in over 35 years. 

Investors saw solid returns across asset classes in the quarter, despite concerns about valuations. Positioning reflected confidence in sustained, above-trend growth and stable expectations for long-term rates and inflation. So far this year, investors are flocking to commodities, Real Estate Investment Trusts (REITs), and other beneficiaries of a strong recovery. Both fixed income and equities continue to draw inflows, and retail interest in stocks is close to a 10-year peak according to TD Ameritrade.1 Major U.S. stock indices closed at or near all-time highs, with the S&P 500 closing at a new record. With a year-to-date total return through second quarter of over 15%, investors already have booked what’s normally considered a more-than-respectable full year gain. A reprieve in rates along with tighter spreads moved fixed income back into the positive column for the quarter. Credit spreads continued their march downward as investors searched for yield which proved to be elusive. Non-investment grade credit ended the quarter at an all-time low yield of 3.75%. 

The economy rebounded as consumers returned and companies invested for expected demand. Growth may reach double digits for the quarter with current consensus for annualized Q2 growth at 10%. This would build on the strong 6.4% rate of expansion in Q1 and is reflected in consensus growth of more than 6% and 4% for this year and next.2 Optimism is evident in both consumer and corporate data. The Business Roundtable’s CEO Economic Outlook Survey, reflecting 15 years of data, showed a near record outlook and the strongest hiring plans in the time series.

Companies are hiring

U.S. JOB OPENINGS (JOLTS)

Source: Bloomberg, as of 04/30/2021. The data spans from 12/31/2000 through 4/30/2021.

Additional spending remains a potential tailwind

Despite a booming economy, the Biden administration continues to spend to “Build Back Better” to drive inclusive growth. Congress passed a $250 billion package to counter China through investment in critical manufacturing and increased basic research. The president continues to seek additional commitments for traditional infrastructure and human capital investments. Roads and bridges garner bipartisan support, but disagreement on tax increases and higher entitlements are proving tricky to resolve. Additional spending remains a potential tailwind.

About two-thirds of the adult population has been at least partially vaccinated. Unemployment remains elevated, but signs point to considerable strength in labor demand. People are hungry to return to normal and are spending some of their excess savings and market gains, driving supply/demand imbalances for everything from homes to cars. Global supply chain issues and shifting consumer spending have lifted inflation to unfamiliar heights, well above the Federal Reserve’s (Fed) target of 2%. There is a strong case that many of the price pressures are transitory and will work themselves out as economic activity returns to a normalized state. At the same time, companies are betting that the strength in the economy has staying power. Management is talking about wage and price increases more confidently than investors are used to hearing. Combined with a continuation of massive government spending and easy money, the economy feels hot.

Input prices are through the roof

INSTITUTE FOR SUPPLY MANAGEMENT (ISM) MANUFACTURING BUSINESS PRICES INDEX 6-MONTH MOVING AVERAGE

Manufacturing business price index

Source: Bloomberg, as of 06/30/2021. The data spans from 7/31/1996 through 6/30/2021.

Easy money risks inflation

The Fed’s commitment to rock bottom short-term rates is amplifying easy financial conditions. Despite what appear to be building price pressures and worries about valuations, interest rates remain well-anchored to the Fed’s narrative. Treasury buyers believe that short rates will remain low for some time, and term rates price in the view that policymakers won’t let inflation spiral out of control. Expectations for above trend growth and inflation have steadily increased this year, but rates remain well behaved with the 10-year trending back below 1.5%. The net effect is that investors continue to accept treasury rates that don’t exceed expected inflation, as measured by the 10-year Treasury inflation-protected securities (TIPS) breakeven rate of 2.34%.  

The big question on investors’ minds is whether policymakers can thread the needle as they seek to jump-start the economy into a higher gear. Investors are navigating a new environment where coordinated fiscal and monetary policies are pushing the edge of the envelope in an attempt to tip the economy into a higher, but still sustainable growth trajectory. The hope is that booming growth will rebalance the economy painlessly, prompting a virtuous cycle of demand, investment, growth and higher wages without excessive inflation. A more skeptical reading of the situation holds that central banks and government spending are creating a demand shock at the same time a reversal of globalization and a stagnating workforce are constraining supply. The near-term outlook is for growth and inflation to clearly exceed the conventional wisdom on each. For now, we believe the economy is in a sweet spot. Jobs are plentiful, and workers are likely to return in force in the fall. The real economy will almost surely reach a new record in 2021 thanks to soaring productivity. 

Economic data never follow a perfectly smooth trend. With easy wins in the rearview mirror, data are likely to be more mixed against above trend expectations. There’s little worry that growth would fall to a concerning level, rather the focus is on whether it will be too much of a good thing. The ups and downs of each new report become more meaningful in this environment as investors focus intensely on reading the tea leaves. As things return to normal in the fall, we expect strong growth and higher prices to challenge investors’ fortitude as well as the conviction of policymakers.

Solid returns

Investors saw solid returns across asset classes in the quarter, despite concerns about valuations.

Source is Bloomberg, Federal Reserve, TD Ameritrade, The Business Roundtable and Securian Asset Management, Inc. for all information, unless noted otherwise.

Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. This commentary should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. Investors should keep in mind that markets are volatile and unpredictable. Past performance is no guarantee of future results. Opinions expressed herein are those of Securian Asset Management, Inc., only. The Economy and the Markets has been prepared for informational purposes only and is the opinion of Securian Asset Management, Inc., a registered investment advisor.

Securian Asset Management, Inc., is a subsidiary of Securian Financial Group, Inc.

For Institutional Investment Use Only. Not for redistribution or public use.

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