Stocks are near record highs. Housing prices are soaring. Inflation is running wild.
The Covid-19 pandemic has helped create a financial environment beset by unusual (and perhaps unsustainable) spikes in asset prices.
The rapid shutdown of the economy in the spring of 2020 led to a brief but painful recession. But the resulting reopening has caused a massive boom that has some wondering if America is now in the midst of a new Roaring Twenties … just like 100 years ago.
Still, there are indications that the economy and market may soon be reaching peak levels – for just about everything.
“What will the return to the new normal look like? We may soon be past the peak,” said Yung-Yu Ma, chief investment strategist with BMO Wealth Management.
Earnings momentum should begin to fade
Investors and consumers should prepare for the possibility that the economy may finally start to settle down in the latter half of 2021 and into 2022, especially if the Delta variant becomes an even bigger problem.
Stocks may have a tougher time advancing as valuations grow more expensive and earnings growth inevitably cools.
Price-to-earnings ratios for stocks are well above their five- and 10-year averages, according to estimates compiled by FactSet.
Meanwhile, analysts think earnings for the S&P 500 surged nearly 90% in the second quarter from a year ago. But that will probably be the top growth rate for the foreseeable future.
Earnings growth is expected to fall to 28% in the third quarter and 21% in the fourth quarter. In 2022, profits are only anticipated to climb 9.5%. Once investors realize that this could be the peak of corporate earnings growth, company valuations (and stock market levels) could pull back.
“I do think the markets — all of the markets — have priced in really good outlooks. So there could be more risk to the downside since so much good news has been priced in,” said Tim Schmidt, chief investment officer with Prudential.
Schmidt added that he doesn’t see any bubbles per se, but that the market may be a little ahead of itself.
Housing prices may finally pull back a bit
New home sales dipped in July, a possible sign that buyers are unwilling to lose one bidding war after another in a market where housing supply is still tight.
Renters may be opting to stay put until prices finally cool off a bit. If sales continue to dip, it stands to reason that prices inevitably will fall as well.
Economists don’t expect that will lead to another big housing market crash like the late 2000’s.
But any noticeable slide in housing prices should have a negative impact on the broader economy. That’s because housing makes up about 15% to 18% of the nation’s overall gross domestic product, according to the National Association of Home Builders.
A potential top for the broader economy isn’t all bad news though. Inflation could be less of a problem in the next few months.
Eric Winograd, senior economist with investment firm AB, noted in a recent report that “with the pace of gasoline price increases moderating, we are likely at or near the peak in headline CPI.”
The prices of other goods and services that have experienced gigantic increases due to temporary factors such as supply constraints and a massive, rapid uptick in demand, may cool off too.
“While inflation is high, it likely is at or near its peak,” said Scott Ruesterholz, a portfolio manager at Insight Investment, in a report.
“We will be looking to see if volatile categories that have driven much of the recent surge in prices, like rental cars, hotel rates, and used cars, shows signs of moderation,” he added.
Inflation could cool, but it won’t go away for good
But what happens next in the labor market is the big wild card for inflation. Wages have been rising. And when workers are making more money, that has the most potential to drive longer-term prices higher.
BMO’s Ma said wage pressures should continue to go higher because of permanent changes to the dynamics of the labor market as a result of Covid-19.
Employee shortages in key services industries have forced retailers and restaurants to boost wages to attract more workers.
“We don’t want to be anchored to pre-pandemic norms. It’s a new environment and in a lot of ways things will be very different. Inflation could be persistent for some time to come,” he said.
