Market Update July 2021 – Jobs wanted? Employees wanted!
Half-way through 2021 and market gains have continued to add up. With the “recovery” phase seemingly well behind us, the capital markets have turned to future opportunities with optimism of further progress of the “return to work” paradigm squarely in its sight. Following months of efforts during 2020 to regain previous highs, 2021 has flipped the page and made new all-time highs in the US equity markets with the S&P 500 Index up 15% through June 2021. Global markets have also responded with healthy returns year-to-date through June. Developed international markets (MSCI EAFE Index) are up 9%, emerging markets (MSCI Emerging Markets Index) are up 7% and the Bloomberg Commodity Index is up 21%. Strong results on the back of 2020’s rebound. Can the trend continue, or has it been too much, too fast?
Investors typically digest current market and economic conditions through the context of history. But where in history have we experienced an event such as the COVID pandemic and the ongoing recovery? A quick review helps to frame what might lie ahead during 2021. The initial 2020 rebound started as monetary and fiscal authorities began to act, prompting “value hunting” for opportunities that had dropped too far, too fast. This was followed by further advances in 2020 on the back of growing optimism that COVID could be addressed and eventually managed (i.e., vaccine development). Now 2021’s market gains have provided new highs on the back of growing confidence of the global “business reopening”. And here we are at mid-year with optimism running high that the virtuous cycle will continue to strengthen.
Investors now continue to seek a balance between a recovery mindset and hoped-for further market highs. At the core is a hope/expectation of a credible cycle where re-opening economies result in growing demand for goods and services, thus, requiring increased hiring, leading to rising wages and resulting in increased spending and growing profits. And the data tracking these factors have generally supported that this model is indeed occurring while markets have confirmed their belief in the paradigm with further gains in 2021.
Can this paradigm continue? Have the reasonable future opportunities already been priced into markets? Or will growth continue its comeback? We are at an inflection point and the cases for both sides have merit. For the Bulls, the US economy is on the cusp of further expiration of unemployment benefits, presumably leading to more individuals returning to the workforce and the virtuous cycle noted above. For the Bears, this is known information and is already priced into markets. Each case has it merits. And the tiebreaker may likely be monetary and/or fiscal policy.
With the liquidity that has been injected into the global economy, capital continues to look for a home. And, with interest rates remaining low across the globe, risk-taking tends to be encouraged, which may result in further demand for “risk” assets such as equities and commodities. But it is also likely that this phase will be more volatile in the second half of 2021. What might tip the scales from the Bulls to the Bears? The prior concerns remain in place: rising inflation and/or worsening COVID data. And, once again, the Federal Reserve is a caveat in any market outlook for the second half of 2022.
But, to-date, the prospects of further economic strength, coupled with supportive monetary and fiscal policies tip the scales towards equity prices following growing profits. But it may very well be a bumpier ride.
CHART OF INTEREST – Jobs wanted? Employees wanted!
It is not a secret that to further the COVID-recovery period progress in employment trends is needed. This is not only a sign of recovery, but a necessary condition for the repair of the fractured economy. Improving employment trends are an essential ingredient for the burgeoning recovery and to stabilize economic growth.
A variety of measures of employment trends and conditions exist that provide data for headline concerns, along with more nuanced gauges of employment health. A particular data point that currently has the attention of the Federal Reserve, and thus investors, is the Labor Participation Rate (LPR), which represents the percentage of the civilian non-institutional population 16 years and older that is working or actively looking for work.
Following a sharp drop in early 2020, the broad measure of LPR rebounded quickly into August 2020, recouping roughly half of the initial decline. Curiously though, since that time the LPR has stagnated, a peculiar condition in the midst of an otherwise recovering environment.
When looking more closely at what may be behind this condition, the chart below shows trends in the LPR over the previous five years, providing further insight into what has been occurring during this recovery. The green line (left axis) displays the trend in participation in the labor force for 25-54 year olds, while the grey line (right axis) depicts the path of those 55 and older. Each cohort saw a relatively sharp drop initially, followed by similarly sharp improvement that followed. But during the summer of 2020, the two groups diverged, with the 25-54 year old eventually getting back to an improving path, while the 55 and older group saw participation slide even lower. We could posit many reasons for this, but for this analysis it suggests pace of further improvement may be hindered as a number of 55 and older participants appear to have exited the workforce.
The message in this picture is more likely a “warning” of a potentially slower than expected, yet still advancing, future economic recovery than it is a sign of the recovery stagnating. Rather than continuing the current pace of economic recovery, could the speed of recovery slow and stretch into 2022? If so, the capital markets would likely experience a recalibration of expectations, possibly in the form of a choppy, sideways period for stocks. And, with the precedents set over past years, investors will be watching for the wild card of fiscal and monetary policy and potential interventions.
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