U.S. stocks are all over the place as Wall Street waits for a catalyst to trigger the next inevitable move higher in Treasury yields. The willingness by the FOMC to begin the discussion over tapering asset purchases could provide some meaningful pressure on bond prices. The Fed is entering a new chapter in this economic recovery as they recently announced intent to sell corporate bonds and ETF’s that were acquired via the emergency-lending vehicle set up earlier in the pandemic. It might take more than a blockbuster nonfarm payroll report to move the interest rate needle, but economic data suggests a swift labor market recovery. The May ADP employment change almost topped 1 million jobs, initial jobless claims fell to 385,000, a post-pandemic low, and the ISM Services Index rose to an all-time high.
Economic overheating is the dominant risk facing the stock market over the next year, despite calls from many economists anticipating the near-term bursts of inflation will recede as normalcy returns. Economists are already debating whether, or to what degree, stimulus spending is fueling inflation. Regardless of the debate, if we add any hotter-than-expected inflation readings or signals from corporate America that pricing pressures are not easing, investors might have to seriously grapple with a Fed that is almost ready to start thinking about tapering.
With the economy still being early in the robust part of the recovery and a large amount of fiscal support from Congress, a substantial stock market pullback seems improbable. However, when it comes to market dynamics, anything is certainly possible. As the economy quickly enters a more mid- to late-cycle environment, investors will continue to look at being constructive on investments benefiting from a more normalized world. With both the path and momentum behind a rising interest rate environment, outperformance will be found in companies with pricing power, balance sheet strength, and solid cash flow metrics.
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