Growth

1Q21 real GDP grew at a 6.4% q/q seasonally adjusted annual rate. Increases were broad based, with the exception of trade and inventories. Personal consumption, the largest part of the economy, surged an annualized 10.7%, the second-fastest pace since the 1960s. Economic output is now only 0.9% below peak 4Q19 real GDP, and an inventory rebound could set the stage for a double-digit surge in real GDP in the second quarter. The ISM Manufacturing PMI eased back to 60.5% in April, from a 37-year high of 64.7% in March, as manufacturers continue to see very strong market demand but grapple with supply chain headwinds. Importantly, the ISM Prices Paid index rose further to 89.6 (vs. 85.6 in March), indicating that inflation pressures are continuing to increase as the economy reopens.

Jobs

Despite falling sharply short of consensus expectations, the April jobs report showed moderate improvement in the labor market and reflects a pandemic economy transitioning to a post-pandemic economy. Nonfarm payrolls increased by 226,000, with strong gains in leisure and hospitality, offset by declines in temporary workers, couriers and messengers, and food and beverage workers. While the unemployment rate rose slightly to 6.1% from 6.0%, the labor force participation rate rose to 61.7% in April. Notably, wages spiked 0.7% m/m and 0.3% y/y. Removing the base effects from last April, wages rose 8.5% on a y/2y basis.

Profits

The 1Q21 earnings season has been impressive, with 435 companies having reported (88.5% of market cap). Our current estimate for 1Q21 earnings is $47.04. Thus far, 86% of companies have beaten on EPS estimates, and 72% have beaten on revenue estimates. Many companies have now recovered to the revenue/EPS levels of 2019 and are setting fresh highs. Blowout reports from big tech also highlight how the pandemic has accelerated key secular growth themes. Oil prices (+48% y/y) and the U.S. dollar (-7% y/y) have provided additional tailwinds to earnings. However, elevated expectations and valuations have caused market recovery plays to pause, awaiting new catalysts.

Inflation

Inflation has now reached the FOMC’s 2% target, as the headline PCE price index rose +0.5% m/m and +2.3% y/y in March. The core PCE deflator also accelerated to +0.4% m/m and +1.8% y/y, matching market expectations. Headline CPI for March was a little stronger than expected, rising +0.6% m/m and +2.6% y/y, while core inflation rose +0.6% m/m and +1.6% y/y. Energy was a main contributor to higher inflation, as prices rose +5.0% m/m.

Rates

The FOMC maintained the federal funds target rate in a range of 0.00%-0.25% and left the pace of asset purchases unchanged. In addition, the median federal funds rate projection—as measured by the “dot plot”—continues to imply no rate adjustments through 2023. Chairman Powell pushed back on tapering chatter and reiterated their view that higher inflation over the next few months will be transitory and thus not meet the threshold for tighter policy. Powell acknowledged the improved growth backdrop, but said that they will need to see it persists to give the Fed comfort about achieving “substantial progress.” The Fed also continued to underscore “risks to the outlook” from the coronavirus pandemic.

Risks

• The emergence of COVID-19 variants and vaccine delays could slow the economic reopening.
• Inflation could spike in the medium term.
• Rising yields could foment equity market volatility.

Investment Themes

• U.S. equity investors can benefit from the recovery with cyclical exposure.
• Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
• Long-term growth prospects and cyclicality support international equities.