Equity markets powered higher in the first four months of 2021, adding to the strong returns in 2020, despite a once in a lifetime pandemic. This led to a swift unprecedented rise in unemployment, a service economy that was decimated globally, and a short-term collapse in corporate profits. Now that the pandemic has begun to wane, S&P 500 earnings estimates have risen, and projections are for higher profits moving forward. Still, stock performance has outstripped the expected pickup in earnings resulting in higher valuation multiples under most metrics. Stocks generally recover quickly after economic troughs, but the performance-to-date has been surprising in magnitude and quickness. The speed at which earnings growth returned is one reason for the stock market rebound. Additionally, the quick economic recovery after the steep decline in the first quarter of 2020 was a big factor.
What should not be overlooked is the importance financial conditions have played in the economic recoveries in the United States and overseas. Congress and Presidents Trump and Biden pushed through massive stimulus packages. The Federal Reserve and other central banks have been extraordinarily accommodative. Credit spreads, after gapping higher in the first quarter of 2020, have now tightened to much lower levels. Consumers are flush with cash thanks to stimulus payments and an inability to spend disposable income. These and other factors have contributed to financial conditions that are among the easiest on record. In fact, they are the easiest on record since the index’s inception in 1982 according to the Goldman Sachs Financial Conditions Index (see chart).
NPP does not expect restrictive policy any time soon. However, the next directional move will almost certainly be toward less favorable conditions. The mountains of global liquidity helped stabilize and then propel asset markets higher. When that begins to fade, the likelihood of an equity consolidation or pullback will rise. This does not mean we think the bull market is about to end. Earnings are rising and the economy is healing. The United States economy is moving toward reopening with some restrictions in the months ahead. Vaccine distribution lags overseas but is slowly improving. There are many positives to offset financial conditions as they begin to tighten from the easiest on record to highly accommodative. We still expect positive equity returns for the rest of 2021, but the pace of equity gains should slow from here.