Fed tapering: Fed Chair Powell said in Jackson Hole that, “at the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year”. The start of the road toward less-accommodative Fed policy has not spooked the market, unlike in some past episodes, but inflation concerns only seem to be mounting at this point. U.S. job openings, for example, are now at the highest level on record dating back to the early-2000s, by a long shot, and supply-side issues (growth negative and inflation positive) look to persist well into next year.
While that sounds like a pretty tough environment for equities, the market continues to push gradually higher. Here are a few reasons why:
Asset inflation: Goods price inflation remains a key factor; wage inflation is a potential concern, but asset-price inflation is still very much alive too. While the focus on this front tends to zero in on areas like housing, commercial real estate and cryptocurrency/meme stocks, it is very much supporting the broader equity market as liquidity on both household and corporate balance sheets looks for a home and/or a hedge.
Longer interest rate view: While Fed tapering is the next major policy move on the radar, it appears the market is still comfortable assuming a low-for-long interest rate environment post-COVID. For now, 10- and 30-year Treasury yields have settled in slightly below pre-COVID levels. For equities, this has helped ease valuation concerns that were percolating earlier in the year. Indeed, with 10-year yields backing off more than 40 bps from the spring high, the spread between the S&P 500 earnings yield and 10-year Treasury has been able to hold steady around the five-year average, even as prices have continued higher.
Lots of earnings support: The Q2 earnings season was pretty much a blowout. According to Refinitiv’s tally, 87% of the S&P 500 topped analyst expectations, which is well above historical norms. Earnings growth topped 95% y/y and, beyond base effects, the level of earnings on the S&P 500 has surged more than 20% above pre-COVID levels. Combined with the decline in longer-term interest rates, this has helped justify the move in prices. And, it reinforces that, even as Main Street continues to face some challenges, big businesses that trade on the S&P 500 can still thrive.