May Private Client Letter

“The best way to predict the future is to create it.” - Peter Drucker

The pace of economic recovery, following the painful COVID-19 shutdowns, appears to be accelerating.  The initial estimate of real GDP growth shows that the economy surged at an annual rate of 6.4% in the first quarter of 2021.  Double-digit personal consumption growth led the way in the first three months of the year due to widely available vaccines and fewer restrictions on business activity.

In addition, the Commerce Department's report also showed that businesses boosted investment in equipment by a 16.7% annual rate.  This will likely serve as a catalyst for future growth in productivity. Home building was another strong sector, with residential construction up at a 10.8% annual rate.

At the heart of this acceleration was the largest single-month increase in personal income going back to at least 1946.  While much of this increase was driven by stimulus payments from the American Rescue Plan, private-sector wages and salaries increased a solid 1.1% in March taking these income measures up 5.6% in the past year.  Private sector earnings now stand above pre-COVID levels. 

As the economy continues to reopen, we expect personal income will continue to rise alongside impressive gains in employment levels across the country.  It is likely that we will see pockets of labor shortages as businesses rush to meet a surge in consumer demand.

Consumer spending experienced a meaningful upswing in March with retail sales pushing higher by 9.8%.  Remarkably, even as consumers are spending more money, personal incomes are rising at a faster pace.  The nation’s savings rate jumped over 27% to the second-highest level on record, and much higher than the average pre-crisis saving rate of 7.5%.  Not surprisingly, this has produced an upbeat April consumer confidence reading suggesting the recent momentum will likely carry forward.

As impressive as the Q1 numbers are, we believe the full-year 2021 consensus GDP growth forecasts underestimate the full extent of the rebound activity as the vaccinations reach levels associated with herd immunity. It is entirely possible that growth could be significantly above what is imbedded in the consensus projections – as good as they already are.

As for U.S. equity markets, we are only four months into the year, but already we have seen 25 record closing highs for the S&P 500.  This already qualifies as an above average year.  However, as a percentage of trading days, it has been an even better year with record closing highs on almost a third of all trading days.  If the current pace keeps up, 2021 would go down as a record year surpassing both 1964 and 1995 with new record highs (Bespoke).

Markets are boldly forecasting the end of the COVID-19 pandemic and the associated government actions that stifled economic activity.  Daily new case counts in the U.S. have plummeted from their early January highs and investors are understandably optimistic.  The backdrop is one of a dramatically improving economy, widely available vaccinations, massive levels of fiscal and monetary stimulus, and surging earnings.  While stock valuations are elevated right now, strong breadth measures suggest stocks still may have more upside.

Considering the S&P 500 Index is trading at a P/E of 22 times the consensus earnings estimate for the next 12 months (FactSet), it is fair to suspect a lot of good news is already priced in. 

And then there is one of the best-known investment axioms: “sell in May and go away.”  This is largely because the six months from May through October have historically been some of the weakest months of the year for stocks.  However, stock performance in recent years tell a different story.  Since 2011 stocks have actually trended higher during these “worst months” 80% of the time producing an average return of 3.8% (LPL).

This said, we see further upside potential for stocks between now and the end of the year while the pace of gains is likely to moderate relative to the 11% year-to-date advance for the S&P 500.  With an accommodative Fed, fiscal and monetary policy, along with an economy that is opening faster than nearly anyone expected, we would regard any weakness as an opportunity to add to positions.

For now, the tailwinds for the U.S. economy and equity markets are strong.  We believe this strength will accelerate in the second half of the year and equity prices will end the year higher.  Accordingly, we are officially increasing our year-end fair value target for the S&P 500 to 4,500.  We continue to overweight equities in our portfolio strategies and underweight fixed income relative to traditional targets.

We will continue to monitor all developments closely.  As always, thank you for your continued confidence and trust in Clearwater Capital Partners.  Please let us know if you have any questions. 

John Chapman

May 2021

PS.  Accolades are always nice, particularly when they are received amid a challenging season.  The COVID-19 pandemic put us all to the test and I was especially encouraged to see the recognition James Chapman recently received from Forbes magazine.  In case you missed it, here is the link to the announcement: James Chapman Featured in Forbes as Best-In-State-Wealth Advisor