Peak Growth

By Nicholas Jasinski |  Friday, July 16

On to the Next Scare. Stocks fell to end the week, with the S&P 500 closing down 0.8%, the Dow Jones Industrial Average losing 0.9%, and the Nasdaq Composite falling 0.8%. Each ended the week lower than it started.

We're at the cusp of what is likely to be record-setting earnings season, but there's a new source of angst in markets. “Peak growth” has become the latest boogeyman in markets. That’s the buzzy phrase used nowadays in discussing the rate of change in corporate earnings, U.S. gross domestic product, stock prices, government and central-bank stimulus, and inflation. It’s the trend that matters for investors, and the outlook is moving toward a deceleration on several of those fronts.

It’s a recognition that the easy money has long ago been made in the postpandemic bull run, and that markets and the economy are entering more uncertain, midcycle times. That has pushed quality stocks back into favor, while kicking some of the recent quarters’ biggest winners to the curb.

Economically sensitive S&P 500 energy stocks, for example, have dropped into correction territory since June, as has Cathie Wood’s speculative-growth-heavy ARK Innovation exchange-traded fund (ARKK).

Second-quarter earnings season won't ignite a new rally, despite the fact that S&P 500 earnings per share are expected to soar 62% from a year ago, according to data from Yardeni Research. That’s gangbusters growth. But investors know it’s coming. Stocks have rallied to their record highs and rich multiples this year in expectation of a postpandemic rebound that’s now showing up in the numbers. It follows 48% EPS growth in the first quarter and expectations of 23% and 17% increases in the third and fourth quarters, respectively. In other words, peak earnings growth is here.

The result is that the market faces a tough bar this earnings season: the combination of all-time high prices and lofty expectations. With good news already priced in, stocks will get punished if they disappoint and won’t be rewarded if they simply meet expectations. We saw that with big bank earnings this past week.

The first official estimate of second-quarter U.S. GDP is due at the end of July. Much like earnings, it’s forecast to be a blockbuster rate of growth—but the peak for this economic cycle. Economist consensus calls for a seasonally adjusted annual growth rate of 9.5% in the April-June period, after a 6.4% pace in the first quarter. Following China, which reported a decelerating GDP growth rate this past week, the U.S. economy could see its expansion cool in the second half of 2021. Still great growth, but less great.

A 5.4% year-over-year rise in the June consumer-price index raised some eyebrows this past week. A majority of the increase in prices came from new and used cars, out-of-town lodging, and airfares—all of which can be reasonably expected to ease as the reopening sorts itself out. But wages and primary housing costs also rose, which are seen as stickier forms of inflation.

“The bad news is that we are still not out of the woods, as [inflation measures] are likely to remain elevated through year end and into early 2022,” wrote BofA Securities economists earlier this week. “The good news is that we are likely near the peak, at least for the next few months, as base effects are less favorable and shortage pressures rotate away from goods towards services.”

The focus on inflation and monetary policy will only become more salient in the months ahead, as the Federal Reserve’s rate-setting committee prepares to unveil its timeline for bond-purchase tapering, which could then begin in late 2021 or early 2022. Full-tilt easing by the Fed is getting harder to justify, and peak monetary stimulus isn't far off either.

Put it all together, and the most attractive stocks in the coming months should be those of companies that can control their own destiny without needing to rely on the rising-tide-lifts-all-boats tailwind of the rapid postpandemic recovery—and those that can withstand the negative impacts of hot inflation and shifting monetary policy.

Read about those types of stocks in this weekend's issue of Barron's. I offer a few quality names in the Trader column beginning on page M1, or available online here.

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