The S&P 500 closed at another record high this week as stocks continue to shrug off a wall of worry. Inflation concerns appear to have been replaced for the moment by fears that the delta variant could cause a return to lockdown and sink the global recovery effort. We believe the U.S. is best positioned to withstand the delta threat with its high vaccination rate, but the rest of the world could be at risk. Some of the developing economies have already begun to slow. There seems to be a divergence growing between the path for U.S. growth and the path for the rest of the world. This difference is a likely culprit for an unexpected move lower in the U.S. 10-year Treasury yield over recent weeks. The sudden change has been curious, but it may be setting up a goldilocks scenario for stocks.
Inflation has been a big threat to stocks for much of the year. The fear has been that the Fed could either let inflation run away, causing interest rates to rise in a way that would crush stocks, or that they could tighten monetary policy too soon and stall the recovery. With the rest of the world still struggling with COVID-19, there may be just enough friction to keep the U.S. from overheating. This scenario could allow interest rates to remain tame and the Fed to normalize policy very gradually. In such an environment, we expect stocks to remain the attractive alternative, U.S.-based stocks particularly. The market breaking to a new high might simply reflect bad news is good news.
There are other worries to consider, but right now, the market appears comfortable. The second-quarter earnings season begins next week, and expectations are high. It may be difficult for companies to surprise to the upside and potentially easy for them to disappoint. It wouldn't surprise us if markets got choppy over the next several weeks, but we will be focused on what the companies are saying about the long-term. We think that productivity might be one of the most overlooked aspects of the current landscape. After a year in lockdown, many companies have identified ways to improve their efficiency and are ready to make the technological leap to get there. For us, that means fatter margins and more cash to return to shareholders through dividends and buybacks. We'll be on the lookout for the companies announcing dividend increases. A dividend increase means much more to us than how quarterly earnings perform relative to what the analysts think. We view a dividend increase as a concrete statement by management that the business is headed in the right direction.
Preston May, CBE®
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