Stocks Rise But Inflation Lurks

Fiscal and monetary policies have flooded the world with liquidity, keeping bond yields at historically low levels. The Fed is buying virtually all the new Treasuries, which are being issued to finance the unprecedented level of government spending. As money supply growth recedes and the Fed starts tapering (i.e., buying fewer bonds), yields could rise depending on what corporations and individuals do with excess cash. On the inflation front, while some commodity prices are receding, demand for rents and labor are increasing. Fed Chairman Powell says inflation is transitory; that is true in some situations. There was a temporary shortage of lumber. There was never a shortage of trees. There wasn’t a shortage of oil, just a shortage of barrels being produced. A little over a year ago, oil was below $20 a barrel. At $75 per barrel there is lots of incentive to produce. Not surprisingly, OPEC and Russia have announced agreements to start producing more. However, rent and wage increases are more permanent. If inflation becomes enduring, the Fed may have to adjust its plans.

In the meantime, the reopening of the economy has led to incredibly strong corporate earnings. With 60% of the S&P 1500 companies reporting, second quarter revenues are up 27% and earnings are up 99% from last year’s depressed levels. Compared to 2019’s second quarter, revenues and earnings are up 14% and 23%, respectively. The second quarter reported earnings are 17% above consensus expectations with all 11 sectors reporting positive surprises.

Big tech led the earnings parade as Apple, Alphabet (Google’s parent company) and Microsoft all posted results well above their respective high expectations. The strong consumer spending in the second quarter GDP report was confirmed by large revenue and earnings gains from companies including Amazon, Home Depot, Wal-Mart and Visa. Earnings growth from energy giants Exxon and Chevron reflected the big move up in oil prices as driving and flying picked up. Financials have benefitted from reversing loan loss reserves that were set aside during the pandemic lockdown and ultimately were not needed.

While earnings have been incredibly strong, rising inflation has lowered valuations since the start of the year, but year-to-date stock returns remain strongly positive. Markets still have not experienced a 5% correction since last year, when history shows it is not unusual to experience 2-3 corrections of 5-10% annually.

The U.S. has 9.2 million job openings and 9.5 million unemployed people, with workers quitting jobs at a near-record rate. Generous jobless benefits for low-paid workers and school closures that forced parents to work from home are expected to disappear this fall. With Covid cases rising, what will come next is especially unclear. Finding companies that can succeed in various economic environments continues to be our focus.

Many thanks to those who have listened to and provided feedback on LVM’s podcasts. We look forward to providing more education through additional podcasts.

The LVM Team

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