2021 MIDYEAR OUTLOOK
INTRODUCTION: PICKING UP SPEED
In the first half of 2021, the U.S. economy powered forward faster than nearly anyone had expected. As we were writing our Outlook for 2021 in late 2020, our economic views were significantly more optimistic than consensus forecasts—but in retrospect, not nearly optimistic enough. Our theme was getting back on the road again and powering forward. But as the economy accelerates to what may be its best year of growth in decades, power has been converted to speed and we’re trading highways for raceways.
Speed can be exhilarating, but it can also be dangerous. The overall economic picture remains sound, likely supporting strong profit growth and potential stock market gains. But the pace of reopening also creates new hazards: Supply chains are stressed, some labor shortages have emerged, inflation is heating up—at least temporarily—and asset prices look expensive compared to history.
Markets are always forward looking, and in LPL Research’s Midyear Outlook 2021: Picking Up Speed, we help you keep your eyes on the road ahead. The next stretch may be a fast one and will have its share of opportunities, but also new risks to navigate. As always, sound financial advice can be as important as ever to help steer you through the environment and put in the miles toward meeting your long-term financial goals
ECONOMY: SPEEDING AHEAD
The U.S. economy has surprised nearly everyone to the upside, as it speeds along thanks to vaccinations, reopening, and record stimulus. The growth rate of the U.S. economy may have peaked in the second quarter of 2021, but there is still plenty of momentum left to extend above-average growth into 2022. Despite the natural challenges of ramping back up, the recovery still seems capable of providing upside surprises.
We forecast 6.25–6.75% U.S. GDP growth in 2021, which would be the best year in decades. Last year’s 3.5% drop in GDP, the worst year since the Great Depression, may not be forgotten—but it has been left in the dust of 2020.
We continue to watch inflation closely but believe recent price pressures are transitory and will begin to work their way off gradually later in the year. The average U.S. expansion since World War II has lasted five years and much longer over the last few decades. There’s nothing on the horizon to indicate the current expansion can’t reach that mark.
POLICY: TAKING A BACK SEAT
The economy was supported through the pandemic by more than $5 trillion in stimulus measures and extraordinary support by the Federal Reserve (Fed). Policy was also in the foreground as safety restrictions created a heavy economic burden for many businesses and families. But policy will take a back seat in 2021 as reopening and private sector growth replaces stimulus checks.
The biggest policy risk may be around taxes, with businesses and wealthy households both facing the prospect of a higher tax burden to pay for the plan and help manage the deficit. Historically higher personal tax rates have had only a modest impact on markets, but higher corporate taxes would have a direct impact on earnings growth, potentially limiting stock gains.
STOCKS: GAINING GROUND
The second year of a bull market is often more challenging than the first, but historically still usually sees stocks climb higher. We expect the strong economic recovery to continue to drive strong earnings growth and support further gains for stocks. However, after one of the strongest starts to a bull market in history—including a nearly 90% gain off the March 23, 2020 lows through June 28, 2021—stock prices reflect a lot of good news. As inflationary pressures build and interest rates potentially rise further, the pace of stock market gains may slow.
Economic improvement should continue to support S&P 500 earnings, which had a stunning first quarter. While valuations remain somewhat elevated, we think they look reasonable after considering still low interest rates and earnings growth potential. Our 2021 year-end S&P 500 fair-value target range of 4,400–4,450 is based on a PE of 21.5 and our 2022 S&P 500 EPS forecast of $205.
BONDS: SAFETY FEATURES
Interest rates have moved off their historically low levels in the first half of the year, but we believe they can still go higher. Higher inflation expectations, the strong economic recovery, and a record amount of Treasury issuance this year are all reasons why we believe interest rates can move higher. Our target for the 10-year Treasury yield at the end of 2021 is between 1.75% and 2.0%.
Such a move would leave core investment grade bonds near flat over the rest of the year. Nevertheless, bonds still can play an important role in a portfolio as a source of income and as a diversifier during equity market declines.
We are also closely watching the Fed, which may announce plans to reduce its bond purchases later in the year. Any withdrawal of Fed support will likely be small, but could send signals on the future path of rates.
Midyear Outlook 2021: Picking Up Speed was designed to help you navigate a year in which economic conditions may continue to improve dramatically. Understanding the road immediately ahead is essential for navigating its twists and turns, but it will be thoughtful planning and sound financial advice that will keep us on the journey.