The global economy, and the United States in particular, continued to see a robust recovery in the first half of 2021 driven by economic re-opening, loose monetary conditions, strong fiscal support and a resurgence in global manufacturing.
Some supply bottlenecks and base effects as prices were compared to last year’s depressed levels combined to drive high inflation readings, leading to concerns of a hawkish shift in monetary policy. The US Federal Reserve, for its part, has continued to insist that the high inflation we’re seeing is transitory. Value and cyclical stocks, benefitting from the recovery, led early in the year, but the market rewarded quality and growth in the second quarter as cyclical valuations inflated and the market contemplated whether economic growth could be peaking.
Equities are supported by the economic tailwinds mentioned above. Valuations appear stretched, but consensus has continually lagged reported earnings growth, as demonstrated by positive earnings surprises. This creates an opportunity for a “benign derating” that is driven by earnings growth rather than price declines. Nevertheless, higher valuations may create higher risk of a market correction. Monetary policy shifts, tax increases, Fed tightening and COVID variants appear to be the most significant concerns for investors as we move into the second half of the year.
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