Economic Monitor: Change Is Constant

BY: Mark Drachenberg


The only constant in life is change. Never has that been more true than today. At the start of 2020, the economy was strong and growing, the markets were heading ever higher, and masks were nowhere to be seen except on Halloween. But seemingly in an instant, things changed – and continue to do so. First, decidedly for the worst, but increasingly of late, for the better.

Things will be changing here in this space, too: Starting this month, the commentary will consist of four sections: Financial Markets, Economy, Fed Watch, and an Outlook/Summary. We hope you enjoy the new format, and we welcome your comments and suggestions. We likewise hope that we will prove that old adage about change wrong by not continually tinkering with the format of this report.

Financial Markets

April bounced around a bit, but ended nicely in the black. All major indices that we follow finished the month in positive territory, including the Barclays US Aggregate Bond Index, which has struggled so far this year. Equity indices were led by the NASDAQ and the S&P 500, both of which posted one-month returns in excess of 5%. The international EAFE index gained 2.73%, as European stocks have done well for several weeks now. While the US Aggregate Bond Index gained ground in April, it is still down 2.61% in 2021 due to rising interest rates. As has been the case much of this year, value-oriented stocks have outgained their growth rivals. Even with their recent strong growth, they remain undervalued to growth stocks, meaning there is likely more room to run. 

Economy

The economy is going strong now, and is expected to continue gaining ground as the year unfolds and the virus is pushed further into the background. Last year’s rollercoaster ride finished with our nation’s gross domestic product falling 3.5%, although that was nothing compared to the second quarter’s annualized decrease of 31.4%, which was the worst economic contraction since World War II. The rebound started, in the third quarter, which saw the economy grow by an annualized rate of 33.4%. Talk about a wild ride! It continued to recover in the fourth quarter last year and into this year. Initial estimates for the first quarter of 2021 showed our GDP gaining 6.4%, and annual estimates for 2021 are running as high as 7% to 8% or more. Should those numbers hold, the economy should finally be able to fully climb out of the hole created last year.

The jobs picture is improving, as the unemployment rate is falling and is now down to 6%, although there is much more to do to reach full employment again. The gain of 916,000 jobs in March was exciting news, but could very well pale in comparison to the expected million-plus jobs per month expected this summer and into fall. Household balance sheets look exceptionally strong, as consumers wait patiently (although much less than over the past year) to travel and take part in other activities that were normal just 15 months ago.

Finally, housing numbers remain strong even in the face of rising interest rates. Buying a home in the suburbs suddenly became fashionable again!

Fed Watch

While the positive economic news over the past year has led to heightened concerns over inflation and interest rates, the major concern is over what the Fed may or may not do. The Fed has taken a very dovish stance throughout the COVID-19 crisis, and has helped facilitate a very easy monetary policy in Washington. While no one denies that this was a proper response, the concern is the future, not the past.

With inflation sprouting over the past year, all ears have been tuned to the Fed frequency to try and pick up any nuance in what the Fed says about the economy, inflation, and/or interest rates. Any sign that the Fed might just be thinking about tightening a bit has become worrisome for the markets and, therefore, the Fed has taken great strides to reaffirm its position, even considering stronger economic growth.

The Fed has acknowledged that inflation has picked up, but also noted that any temporary spike in inflation is expected to be just that – temporary. It continues to stress that inflation can run somewhat higher than its 2% target without causing the need to tighten. At this point, it is steady as she goes, and the Fed does not plan on tapering its asset purchases or raising interest rates any time soon. That is good news for the markets, even if some continue to fret over the chance that the Fed may hint at something different someday.

Outlook/Summary

As has been mentioned in past months, the picture is very bright for the economy over the next couple of years and perhaps longer. The key is to not overheat and cause a rapid and sustainable rise in inflation, ultimately causing the Fed to act sooner than it desires.

The markets, though, may be a different story, at least in the short to intermediate term. We stress the word “may,” as certain pockets have room to run (value, international, recovery sectors, etc.,) while others (growth, tech, biotech) may need to take a breather for a bit. Do not be surprised if certain sectors, or even the market as a whole, face a correction sometime over the next 6 to 12 months. Getting rid of the froth is a normal market condition and could very well be what the market needs to move substantially higher.

At this point, limiting your exposure to interest-sensitive growth stocks will lessen some of the volatility. Utilizing value stocks, laddering CD’s, individual bonds, and/or defined maturity bond funds, floating rate funds, and stocks of companies with healthy dividends should be considered to diversify and enhance portfolios and provide downside protection. To discuss your portfolio or any other issue you may have, please reach out to me or call the Wealth Management department of at (608) 826-3570. We look forward to speaking with you.

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