Macroeconomic & Geopolitical

Approaching Apogee

May 2021 – 3 min read
Even as the U.S. economy rockets higher, last week's jobs miss will start to raise questions about what is a sustainable trajectory.

With economic data sizzling, commodity prices soaring, and markets braced this week for yearly U.S. consumer price inflation that could top 3.5%, bond markets have responded with a collective yawn. Even a media flurry around some loose talk about rising rates from Treasury Secretary Janet Yellen last week barely moved 10-year yields.

Meanwhile, stocks have essentially shrugged at one of the most impressive earnings seasons in a decade. Nearly 9 of 10 company reports so far have beat expectations handily, delivering annual earnings growth above 45%, almost double estimates a month ago. The S&P 500 has been essentially flat. 

Could it be that markets have set aside inflation worries for now to focus on growth? Should we be watching for signs that the rocketing economy may be approaching apogee? Last Friday’s disappointing jobs numbers are probably not as bad as they looked, but they are a reminder that the data can’t improve indefinitely.

Investors don’t seem worried enough to sell risk assets here as the good news keeps on coming, but few seem brave enough to buy without a better sense of the long-term growth rate. The task now will require a better understanding of President Joe Biden’s next budget and a stress test of every business model in the portfolio. 

Naturally, stock valuations continue to keep many investors wary, although price-to-earnings ratios have fallen toward the low 20s on rising estimates. Bond yields may be capped for now as global investors consider 1.6% on U.S. Treasuries a good deal when Japanese Government Bonds pay nothing and German Bunds are still negative.

“Investors don’t seem worried enough to sell risk assets here as the good news keeps on coming, but few seem brave enough to buy without a better sense of the long-term growth rate.”

But the broader question coming into view remains where sustainable growth rates will settle. The ISM Manufacturing PMI raised a few eyebrows when it came in at 60.7—a glorious reading in any other context, but still down from the previous month’s peak. If a narrow survey seems unimpressive, consider that the Atlanta Fed now projects second quarter GDP growth will top 13.6%, but few expect a higher number for the third quarter.

Even if China’s red-hot recovery delivers more than 8% growth this year as estimates suggest, the very same forecasters call for a sharp deceleration to below 6% in 2022. European growth should catch up to the U.S. as faster vaccination programs allow reopenings in time for the summer tourist season. Still, if eurozone growth actually meets this year’s consensus above 4% growth, the risks to next year’s number are to the downside. 

In some ways, this quarter is the mirror image of the dark days of last summer’s reports on the second quarter of 2020. Then, as you may shudder to recall, the numbers were so bad and the outlook was so dark that managers abandoned any pretense of guidance. The actual results were more a damage report than a useful data point that could help trace longer earnings trajectories.

If that news was too bad to last, today’s is too good. This makes it difficult for analysts to assess credit risks or set price targets. 

A large part of that uncertainty in the U.S. comes from the Biden administration’s proposals to spend more than $4 trillion on infrastructure, education, and family subsidies. It’s hard to imagine those amounts will have no effect in boosting economic growth, even if they are accompanied by higher corporate and income taxes. Still, the impact will be differentiated, spread over time and shaped by the deductions and exclusions in any new revenue bill. 

In Europe, next year’s fiscal picture looks more supportive, but there will be similar questions around just what impact grand schemes to invest in “green” and “digital” activities will provide. China is planning massive investment schemes, too, as part of its 14th Five Year Plan, and investors will have to decide where these could create opportunities.

Careful investing also requires a parallel assessment of the business models that emerge as effects of the crisis fade. What will the new sustainable patterns of demand look like once the summer blowout subsides? Which companies have enough pricing power to pass along rising input costs, and which ones will see margins squeezed? Where will new technologies, everything from machine learning to blockchain, start to chip away at what were once reliable earnings generators?

The global economy continues to recover at a stunning rate, and the current momentum should last well into the fall, and perhaps even into next year. But sooner or later the laws of gravity will kick in. The hard work now lies in identifying when and where.

U.S. Real GDP Growth Consensus Progression

Source: Bloomberg. As of April 30, 2021.

China Real GDP Growth COnsensus Progression

Source: Bloomberg. As of April 30, 2021.

Eurozone Real GDP Growth Consensus Progression

Source: Bloomberg. As of April 30, 2021.

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