This story originally appeared on Zacks
The stock market’s recent behavior has been nothing less than spectacular and one for the record books.
The market rebound that got underway in March last year still continues, with the major indexes at or near record levels. Helping the stock market’s momentum is optimism about the economy, with the U.S. economy expected to achieve a growth pace of close to +6% this year, despite the growth pace moderating in Q3.
But there are those with less optimism about the outlook given the ongoing resurgence in infection levels and slow-moving vaccination efforts in many parts of the world that are allowing new strains of the virus to take hold. There are worries about inflation as well, with a vocal segment of the market disagreeing with the Fed’s ‘inflation-pressures-are-transitory’ outlook.
The interplay of these competing views will determine how the market performs in the coming months and quarters. To that end, let’s examine the landscape of bullish and bearish arguments to help you make up your own mind.
Let’s talk about the Bull case first.
A Strong Economic Rebound: The Q3 GDP growth deceleration from the first half’s pace is only temporary and reflective of transitory factors like supply-chain bottlenecks and the Delta variant. The overall growth backdrop remains very strong, with the U.S. economy expected to expand by close to +6% this year and more than +4% next year.
Driving this favorable growth outlook is the U.S. household sector that remains in excellent financial health. The unprecedented fiscal support was instrumental in helping keep household finances in good shape through the pandemic, with labor market gains expected to sustain the momentum going forward. In addition to the elevated consumer spending outlook, adding depth to the economic rebound is a strong housing sector and continued factory sector momentum.
These positive growth projections do not include contribution from the new infrastructure plan and other spending measures currently being considered in Congress. All in all, the growth outlook hasn’t looked this good in a long while.
Continued . . .
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Expansive Fiscal Measures: The Biden administration’s ambitious spending plan has not been passed yet, but it is in-line with the extraordinary fiscal measures that have been in place since the start of the pandemic.
Beyond the visible fiscal relief measures, the government’s proactive vaccine investments, under the current and previous administrations, allowed the economy to reopen and successfully handle the Delta variant that remains a problem in many parts of the world. The current U.S. debate about booster shots and children’s vaccines spotlight the vaccine supply abundance in the country that even many rich countries don’t enjoy.
These policy measures helped replace lost wages for workers, assisted small businesses in staying open and staved off solvency issues in industries hit hard by the pandemic. Importantly, these and the coming measures will ensure an extended period of above-trend growth for the U.S. economy for the next few years.
Supportive Fed: While there is some uncertainty in the market about the timing of the central bank’s tactical decisions as it initiates ‘tapering’ the current QE program, the market has a roadmap in the way the Fed concluded its last bond-purchase program in 2014.
Importantly, the Fed’s ‘transitory’ inflation explanation assures that it will be deliberate and patient as it handles this key part of its mandate.
The Fed’s hard-won credibility on the inflation question is one of the biggest tools in its arsenal as it leads the market in the current environment of evolving inflation expectations. What this means is that the central bank will continue to keep interest rates and overall financial conditions supportive of stocks for the foreseeable future.
Let’s see what the Bears have to say in response.
Market Complacency about Economic Growth: The U.S. economy has been unable to sustain the first half’s strong growth momentum, as this week’s Q3 GDP report will show. The market appears too sanguine about the growth deceleration, seeing the trend as resulting from temporary factors like Delta that will reverse from Q4 onwards.
While Covid infection rates have thankfully come down, some of the other headwinds like supply-chain challenges that weighed on the economy in Q3 are still with us. As such, the growth deceleration in Q3 could very well continue in Q4 and beyond. This will be in contrast to current consensus estimates that suggest growth rebounding in the current period (2021 Q4) after losing steam in Q3.
Tied to the growth question is the issue of inflation, which the market appears comfortable seeing from the Fed’s standpoint as ‘transitory’ in nature. The consensus view on growth and inflation could very well be on target, but it would nevertheless pay to be prepared for the dreaded scenario of low growth and high inflation as well.
A Durable Hit to Confidence? The risk to human life, a function of the highly contagious pathogen, has been a unique aspect of this economic downturn. As a result, previously benign activities like eating out or taking a flight or any activity that involved physical interaction with others got weaponized.
Public health officials keep emphasizing that the Covid vaccines provide sufficient immunity against Delta and other variants. This should help sustain the momentum towards increased reopening and social interactions that became the norm in the U.S. since the Summer.
That said, the pathogen has a wide pool of unvaccinated population globally where it can thrive and morph into even deadlier variants. With the new vaccine technology, one would expect a quicker turnaround from the industry to counter any new strain that offers significant challenges to the existing vaccines. But the emergence of any such new strains will nevertheless be a hit to confidence that will have consequences for the markets.
The Market’s Fed Addiction: The market’s Fed dependence has only increased as a result of this pandemic. The central bank not only cut interest rates to near-zero, but has been playing an active role in ensuring market liquidity and backstopping corporate balance sheets.
In an ideal world, the central bank will gradually remove the market’s ‘training wheels’ without creating uncertainty and volatility. But we know that we don’t live in an ideal world, which guarantees the coming period of monetary policy transition to generate uncertainty.
The markets responded calmly to the Fed announcement in July that opened the door for a ‘taper’ decision in one of the coming meetings this year. It is possible that the Fed seamlessly executes this policy change without any disturbance, but the more likely outcome is at least some level of uncertainty that disturbs the markets.
Where Do I Stand?
I don’t dismiss the bearish arguments entirely, but I don’t see them adding up to coming in the way of the U.S. economy’s rebound or reversing the spectacular rally in the market.
With most of the U.S. at-risk population already vaccinated, the risks posed by the Delta variant should be manageable and offer no durable hindrance to economic reopening.
The issue is with regions beyond the U.S. that have far smaller proportions of their populations immunized and are forced to institute fresh restrictions in the face of this outbreak. That said, the worst of the pandemic’s economic and corporate earnings impact is now behind us, with the picture getting clearer as we move forward.
As regular readers of my earnings commentary know, the earnings picture has not been this good in a long time, with estimates for the current and coming quarters steadily going up. This is a trend that I strongly feel will only accelerate in the coming months as we put the pandemic behind us.
Markets are forward-looking pricing mechanisms; they have already discounted the economic rebound and are looking forward to the aforementioned turnaround in earnings outlook. Continued confirmation of this favorable trend will further strengthen bullish sentiment in the market.
These are historic times for the economy and the market. And historic times create historic opportunities.
All in all, this is the best time to be fully invested in the market, particularly if you are investing for the long haul.
And I would definitely be a buyer on any dip because with economic growth this year and next to be the strongest in years, it looks like there’s a lot more upside to go.
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Thanks and good trading,
Sheraz Mian serves as the Director of Research and manages the entire research department. He also manages the Zacks Focus List and Zacks Top 10 Stocks portfolios. He invites you to access Zacks Investor Collection.
¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research’s newsletter editors and may represent the partial close of a position.
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