The U.S. economy will likely continue to zip along in this year’s second half, with equity returns expected to rise and returns on core investment-grade bonds to be flat, according to an economic forecast report released today by LPL Financial.
The broker-dealer’s “Midyear Outlook 2021: Picking Up Speed” report covered a lot of ground, and one of the major takeaways is that LPL predicts 6.25% to 6.75% growth this year in U.S. gross domestic product. If that comes to pass, it would be one of the best years for economic growth in decades.
And LPL’s read on inflation seems to mirror that of the Federal Reserve in that it believes recent price pressures resulting from the economy’s reopening are temporary and will cool off later this year. As such, it expects the U.S. economy to remain vibrant for the foreseeable future.
Nonetheless, LPL recognizes that last year’s recession was highly unusual. For starters, it most likely was the shortest on record. Second, the economic recovery has been aided by unprecedented stimulus, meaning that some imbalances weren’t worked out of the system like in past recessions. Furthermore, corporate debt levels remain high (and that’s supported by low interest rates), while stock valuations didn’t truly reset.
“The good news is this new cycle of growth probably has enough going for it to be at least average, which would still give it another four years,” the report said, noting that the average U.S. expansion since World War II has lasted an average of five years—and even longer in recent decades
Equities
LPL noted that while the second year of a bull market generally isn’t as robust as the first year, it traditionally has produced solid gains. And it believes that continued economic improvement should bode well for strong S&P 500 Index earnings during the rest of the year.
It stated that for bull markets since 1950, the average S&P 500 gain during the second year has been roughly 13%. Attaining that level would put the index slightly above 4,400. It further stated that bull markets, like the current one, that followed 30% or greater declines resulted in an average second-year gain of 17%. If that happened this time around, the index would be near 4,600, or well above the high end of LPL’s year-end fair-value target range.
“While valuations remain somewhat elevated, we think they look reasonable after considering still low interest rates and earnings growth potential,” the company said in its report. “Our 2021 year-end S&P 500 fair-value target range of 4,400–4,450 is based on a price-to-earnings ratio of 21.5 and our 2022 S&P 500 earnings per share forecast of $205.”
Fixed Income
Although LPL said it expects inflation to simmer down by year end, it stated that inflationary pressure and economic improvement could put additional upward pressure on the 10-year Treasury yield, and it predicts the 10-year yield to close out the year in the range of 1.75% to 2.00%.
“Such a move would leave core investment-grade bonds near flat over the rest of the year,” LPL said. “Nevertheless, bonds still can play an important role in a portfolio as a source of income and as a diversifier during equity market declines. We are also closely watching the Fed, which may announce plans to reduce its bond purchases later in the year.”