Balancing the strength of the recovery with potential headwinds on the horizon

Authors: Eric Elbell, Kevin Schmid

The State of Economic Recovery

While the United States continues to work toward moving past the COVID-19 pandemic, the health of the U.S. economy is much less in doubt. The stock market rallied sharply over the final nine months of 2020 in anticipation of a robust economic recovery, and there are many indications that such investor optimism was well-founded. In this update, we will review the current state of the economic recovery, identify potential headwinds on the horizon, and discuss the possible implications for financial markets going forward.

Corporate America's financial outlook on 2021

At a broad level, U.S. gross domestic product (GDP) is poised to surge in 2021 as business and consumer activity normalizes. In the first quarter of the year, real (inflation-adjusted) GDP grew 6.4%1 for the full year, the latest projection from the Federal Reserve pegs 2021 real GDP growth at 6.5%, while the median estimate from 64 brokerage firms is 6.4%2 according to FactSet. These annual estimates reflect a material acceleration of expectations from just three months earlier, as depicted below:

Real GDP Growth Estimates 2
Projections of Federal Reserve

With the economic recovery taking hold, corporate America is rebounding at a swift pace. Survey data published by the Institute for Supply Management (ISM) indicates that business activity in both the manufacturing and services sectors is expanding rapidly; in fact, recent ISM survey readings for both sectors recently hit multi-year highs.3 Meanwhile, corporate earnings are surging: the aggregate earnings of companies in the S&P 500 Index are expected to grow 49% in 2021 off their 2020 lows and continue to rise in 2022.4

ISM Reports on Business 2
S_P 500 Calendar Year EPS

Turning to private households, conditions are growing increasingly favorable for a sustained rebound in consumer spending. American households have benefited from multiple rounds of fiscal stimulus, and the personal savings rate, which skyrocketed last year in the immediate wake of the initial COVID recovery effort, remains elevated relative to recent history. Meanwhile, U.S. household net worth, after a brief but sharp dip in early 2020, has resumed its long-term upward trend, driven in no small part by the massive growth in the value of financial assets over the last 12 months.

Monthly Personal Savings Rate
US Household New Worth

Further, the roll-out of COVID-19 vaccinations and increasing relaxation of pandemic-related restrictions is lifting consumers' spirits, as reflected in the recent spike in consumer confidence.

US Consumer Confidence

To be sure, the employment picture, while improving, is still on the mend. Initial unemployment claims are significantly lower than the staggering levels experienced a year ago, but remain well above recent historical precedent. Furthermore, the 6.1% unemployment rate has declined sharply from its COVID-19 peak but is still a far cry from the full employment the economy enjoyed pre-COVID.

Moreover, as the U.S. recovery gathers steam, rising interest rates and inflation have emerged as potential headwinds. While absolute levels of interest rates remains low relative to history, the yield curve has steepened materially in the last few months, negatively impacting bond prices directly as well as the valuation of long-term earnings for stocks.

US Treasury Yield Curve

Inflation in the U.S. economy has remained subdued for quite some time, but has recently begun to pick up, and market expectations for such, as reflected in the chart to the right below, have been increasing as the economy reopens and businesses face rising costs in areas such as shipping and raw materials, shipping, and labor.5

US Consumer Price Index
Five Year Breakeven Inflation Rate

The Federal Reserve has signaled a willingness to let inflation run above historical average for some period of time before taking any action, and currently believes that near-term inflation pressures will be transitory, but there is a risk that inflation could run higher than expected and force the Federal Reserve to raise interest rates, which could dampen the economic recovery.

Lastly, markets have also wobbled on discussion from the Oval Office and Congressional leaders pertaining to possible increases in corporate and/or long-term capital gains tax rates.


The economic recovery is undoubtedly growing stronger, with multiple avenues for improvement as the country continues to trend closer to normalcy and the COVID-19 pandemic hopefully fades into the rearview mirror. Of course, as financial markets are typically forward-looking, stocks' robust rebound since their late-March 2020 lows indicates that investors already correctly anticipated today's favorable economic trends. The path from here may be less certain, as investors balance the strength of the recovery with emergent headwinds. As always, investors should remain vigilant and disciplined, and mindful of their asset allocation targets and portfolio exposures.


1 According to the first estimate provided by the Bureau of Labor Statistics; the final number will be produced in June, 2021
2 As of 4/30/2021
3 A reading above 50 indicates business activity is expanding
4 As of 5/7/2021
5 The 5-year breakeven inflation rate reflects the difference in yields between nominal Treasury bonds and Treasury Inflation Protected Securities (TIPS) for a given maturity

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