Markets & Research
Growth sprints upward as consumers look beyond the pandemic

Over the past few decades, economic rebounds have tended to start very slowly. Consumers were financially drained from the preceding recessions and huddled into such defensive crouches that it could take years for upturns to actually feel like upturns.

The recovery from the coronavirus pandemic couldn’t be any more different. Americans are flush with cash and spending with an intensity that was inconceivable a year ago. That’s a testament to the combined force of nationwide vaccinations, immense government support and ferocious household demand. It also highlights one of the bigger contrasts between this recovery and its recent predecessors: Household finances are far sounder today, raising hope that consumers can keep powering growth.

The flip side of this scenario is the recent surge in inflation. Prices have jumped more than projected, prompting the Federal Reserve to say it expects to boost interest rates a bit sooner than previously forecast. The spurt in prices has raised talk that inflation could become a lasting impediment. However, some Capital Group economists think that’s unlikely. They expect the price surge to be temporary — stemming largely from pandemic-related shortages of goods, raw materials and labor — and to dissipate as the global economy reopens fully.

Of the forces driving the economy, the strongest of late has been the nationwide vaccine rollout. New cases of COVID-19 have plummeted, spurring states to peel back pandemic restrictions and Americans to stream back to restaurants, shopping centers and airports. Meanwhile, the lofty savings rate has pushed up household wealth and given consumers the horsepower to ramp up spending.

The result has been a roaring expansion — the Fed predicts GDP could surge 7% this year, its biggest gain since 1984 — and a stock market that crackled higher throughout the first half of 2021. Cyclical sectors have led the way, especially energy and financials that stand to benefit from faster growth. Consumer discretionary stocks appear to be well positioned in light of the consumer spending outlook for the rest of the year.

Looking forward, President Biden’s proposed boosts to infrastructure and other spending could spur the economy further, though it’s unclear if either of his two plans can garner congressional support. A bipartisan group of senators recently announced consensus on a $1.2 trillion infrastructure package, a reduction from Biden’s original $2.3 trillion American Jobs Plan but significant nonetheless. Five centrist Republicans have signed on to the deal, but five more would be needed to overcome a potential filibuster. Biden’s other proposal, the $1.8 trillion American Families Plan, is unlikely to attract Republican votes; Democrats likely would need to pass it through so-called budget reconciliation.

The rise in inflation threatens to upstage consumer optimism.

Inflationary pressure doesn’t normally crop up so early in a recovery. But rapidly uncoiling consumer demand has sparked worries about lurking inflation and a repeat of the debilitating price hikes that menaced the economy in the 1970s. The fears stem partly from a Fed policy shift last year that allows inflation to temporarily exceed the central bank’s 2% target, in the belief that spurts of outsize growth can benefit the labor market without touching off a sustained run-up in prices.

The inflation spike is expected to be transitory rather than persistent

This table shows some inflation indicators that can give hints as to whether inflation is transitory or persistent. The three signs listed all suggest 2021's spike in prices will be temporary. First, the inflation isn't broad-based — it's been primarily in parts of the economy considered to have "flexible" pricing. Second, employment levels are still subdued, especially when compared to pre-pandemic levels. Finally, wage and income growth are down, below even recent averages. Source: Capital Group, Federal Reserve Bank of Atlanta, Refinitiv Datastream, U.S. Bureau of Labor Statistics. As of May 2021.
Source: Capital Group, Federal Reserve Bank of Atlanta, Refinitiv Datastream, U.S. Bureau of Labor Statistics. As of May 2021.

Though inflation is expected to spike in the next few months, some Capital Group economists believe it’s a transitory phenomenon concentrated in pandemic-affected areas such as rental cars and airline tickets. Indeed, price hikes have been pronounced in “flexible” categories — goods whose prices can easily be adjusted up or down — while remaining stable in “sticky” areas such as rent, where price shifts are infrequent.

The price spurts stem partly from supply-chain bottlenecks that reflect the difficulty of restarting a global economy that was idle for much of the past year. And the labor shortages that have caused fits for some employers should ease as extended unemployment benefits and other relief programs expire.

As the chart on this page demonstrates, stocks have done well in most inflationary environments. On average, they’ve declined only in periods of deflation and times when inflation pierced 6%. 

Stocks have done well in most inflationary environments

Source: Morningstar Direct, Capital Group. This chart shows average U.S. stock returns in 12-month rolling periods during a variety of inflation scenarios. In light to moderate-high inflation — in which rates ranged from 0% to 6% — equities have all had positive returns. That makes up 81% of all periods. Only in deflationary periods, where inflation was negative, or in very high inflation periods, where it was 6% or higher, did equities have a negative return. This chart covers 601 12-month rolling periods, from Feb. 1, 1970, through Dec. 31, 2020. Returns for U.S. equity used the Ibbotson Associates SBBI U.S. Large Company Stock Index, while inflation used the Ibbotson Associates SBBI U.S. Inflation Index. As of May 31, 2021.
Source: Morningstar Direct. Capital Group. U.S. Equity is represented by the Ibbotson Associates SBBI U.S. Large Company Stock Index. U.S. inflation is represented by the Ibbotson Associates SBBI U.S. Inflation Index. Returns are based on rolling 12-month periods from February 1, 1970, to December 31, 2020. Inflation environments are defined by the rolling 12-month returns of the Ibbotson Associates SBBI U.S. Inflation Index. As of December 31, 2020.

Interest rates remain in check.

Fed policymakers signaled in mid-June that they might hike rates twice by the end of 2023 rather than holding off until the following year. And they’re mulling whether to ease up on purchases of Treasury and mortgage bonds.

Even so, the fixed income market took the central bank pronouncement in stride, and the yield on the 10-year Treasury note actually declined during the second quarter. That contrasts with the 2013 “taper tantrum,” when borrowing costs jumped after the Fed suggested it might scale back its bond buying.

Some Capital Group economists believe the central bank could begin to taper asset purchases later this year or early in 2022. Nevertheless, interest rates are likely to remain low. Our economists believe a rate hike is at least 18 months away and that the central bank will signal any action very deliberately beforehand.

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