The bull and bear case for stocks in Q3

Anthony Saglimbene, Global Market Strategist – Ameriprise Financial
As of July 20, 2021

With the third quarter of the year underway, major U.S. stock averages sit near all-time highs. And bond yields have moved lower on peak growth concerns, lingering pandemic issues and expectations that inflation pressures could moderate with time.

Importantly, COVID-19 dynamics have improved across much of the western world this year, as vaccines have become more readily available. 

Through the first six months of 2021, cyclical stocks led markets higher, and reopening momentum carried most major equity averages higher across the globe. 

But more recently, momentum has shifted back to growth areas, like the Information Technology sector. Concerns about peak growth have given stocks with strong long-term profit drivers a boost, given their ability to grow profits in multiple economic conditions. 

The table below outlines our assessment of the bull and bear case for stocks at the start of the second half. We believe that monetary and fiscal conditions should remain a tailwind for asset prices throughout the year. Investors should skew to a bullish outlook, in our view, given the low interest rate environment and strengthening economic/corporate earnings trends expected to continue through the year (especially in sectors of the economy most depressed by the pandemic). 

The bull case for stocks The bear case for stocks
It's still a bull market  Valuations still stretched virsus history
Federal Reserve support remains massive Fadings momentum across cyclical stocks (recently)
"Don't fight the Fed" & "TINA" still in play Slowing trends across housing
Stocks trump bonds in a low rate environment Peaking economic activity; What's next? 
Strong fiscal support; Potentially more stimulus coming Slower-than-expected recovery across leisure/hospitality jobs
Strength begets strength Areas of the business community still experiencing pain
COVID-19 vaccines helping return the world to normal Global supply chains remain disrupted by pandemic effects
The U.S. consumer is able and willing to spend  Semiconductor shortage is adding to supply bottlenecks 
Reopening trends broadening to areas most depressed by the pandemic COVID-19 vaccine adoption has hit a wall in the U.S.
Strong manufacturing  What if inflation is more persistent than expected? 
Peak economic and corporate earnings growth  Fed policy mistake 
Peak inflation could temper investor jitters regarding Fed policy Stocks reflect most of the "bull" case today
Sector participation broad; Still favors cyclicals  No meaningful correction across the S&P 500 Index in several quarters
Stock opportunities growing in areas outside the U.S. Opportunities for outsized stock gains are skrinking 
Earnings growing into stock valuations Stocks have a lot to live up to
Sources: Bespoke Investment Group and American Enterprise Investment Services Inc. 

In addition to the bull and bear case outlined above, here are three big-picture market themes for investors to consider this quarter: 

  • Expect huge Q2 corporate profit numbers, but stocks have already priced in the eye-popping surge. In our view, given the already elevated expectations, stock prices could react more to second quarter earnings reports (starting this month) that help color the outlook  for growth through the rest of the year. For instance, analysts expect S&P 500® Index earnings per share (EPS) to grow by +64% year over year in Q2. While aggressive Q2 corporate profit beats could help drive stock prices higher through the earnings season, we believe investors will be far more focused on corporate insight regarding supply disruptions, labor shortages, profit margins and inflation impacts. As a result, corporate commentary and outlooks that address these issues may have a more meaningful impact on stock prices through the front half of Q3. 
  • Inflation will remain a hot-button topic throughout the quarter. Investors have a good handle on inflation impacts from year-over-year comparisons and reopening momentum. However, it may become more evident over the third quarter how temporary or enduring inflation becomes. The Federal Reserve and a number of economists believe inflation pressures should moderate in the back half of the year and into next year. On the other hand, we believe data that shows inflation pressures rising or remaining at elevated levels could quickly become a headwind for stock prices. 
  • The Federal Reserve and potential policy shifts could stir market volatility in late summer. Investors are unofficially targeting the Fed’s Jackson Hole Economic Symposium in late August as the launch point for more details about the central bank’s bond-tapering strategy. While we believe it’s unlikely the Fed will begin to reduce its $120 billion-a-month in government/agency bond purchases until next year, the setup for communicating its approach will likely be transparent and proactive. Though we believe Fed policy will remain ultra-accommodative for the foreseeable future, a wildcard for investors is how stock prices react to the idea of slightly tighter financial conditions moving forward. 

Notably, stocks are not cheap today given the elevated valuations. Considering the lingering pandemic issues around employment and global supply chains, combined with a still-undetermined path for where inflation pressures ultimately land, investors should take a pragmatic view of market opportunities in the second half.

While stocks have a lot to live up to, the world is reopening and returning to normal business activities. Consumers and businesses are able and willing to spend, which should drive corporate profits in the second half. Overall, we believe the setup for stock prices remains solid. 
 


Data source for indices and sector graphs: Morningstar Direct, as of July 12, 2021.

Past performance is not a guarantee of future results.


Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
The views expressed in this material are as of the date published and are subject to change without notice at any time based upon market and other factors. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. This information may contain certain statements that may be deemed forward-looking. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those discussed. There is no guarantee that investment objectives will be achieved or that any particular investment will be profitable.
This information is being provided only as a general source of information and is not intended to be the primary basis for investment decisions. It should not be construed as advice designed to meet the particular needs of an individual investor. Please seek the advice of a financial advisor regarding your particular financial concerns.
Information provided by third parties is deemed to be reliable but may be derived using methodologies or techniques that are proprietary or specific to the third-party source.
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
A fund may invest significantly in issuers within a sector that may be negatively affected by market, economic or other conditions, making the fund more vulnerable to unfavorable developments in the sector.
Past performance is not a guarantee of future results.
An index is a statistical composite that is not managed. It is not possible to invest directly in an index.
The S&P 500 Index is a basket of 500 stocks that are considered to be widely held. The S&P 500 index is weighted by market value (shares outstanding times share price), and its performance is thought to be representative of the stock market as a whole. The S&P 500 index was created in 1957 although it has been extrapolated backwards to several decades earlier for performance comparison purposes. This index provides a broad snapshot of the overall U.S. equity market. Over 70% of all U.S. equity value is tracked by the S&P 500. Inclusion in the index is determined by Standard & Poor’s and is based upon their market size, liquidity and sector.
Definitions of individual indices mentioned in this article are available on our website at ameriprise.com/legal/disclosures in the Additional Ameriprise research disclosures section, or through your Ameriprise financial advisor.
Third party companies mentioned are not affiliated with Ameriprise Financial, Inc.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Ameriprise Financial Services, LLC. Member FINRA and SIPC.