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We just finished a first half of the year which saw the S&P 500 post 34 record daily closes. The final day of the quarter was one of those closes with the S&P 500 at the record level of 4297.5.  Like many investment professionals, we contemplate what to think of this situation. We liked the headline of one article which posed this question: “What should we expect if ‘peak everything’ has already happened and the markets feel the force of gravity again?”

On one hand, the mood should be ebullient. The rebound of the U.S. economy is undeniable. Corporate earnings have shined, and most S&P 500 companies have issued strong positive guidance on sales and earnings for the second quarter.

Nonetheless, there is considerable unease among the investor class. Many market analysts believe the economy’s rebound has been fully built into stock valuations. Given the current levels of the market, to many analysts, stocks seem priced for perfection.  This means they may be challenged to go higher. More worrisome, it might not take much bad news to send stocks lower.

Three months ago, we wrote that the market was ready for a “pause” from the growth of the last year. We do think that some upward movement is still possible in 2021. We also think a bit more grounding – recognizing the forces of gravity – would not be a bad situation either. We are ready at Hudson Advisors to navigate across this somewhat unprecedented terrain -- managing client portfolios both defensively and with an eye to long-term opportunity.

The Economy:  The U.S. economic recovery is fully underway. The forecast for expansion of GDP in 2021 is almost 7%.  Data on hiring, consumer spending, and small business confidence have bounded back from their pandemic low points. This expansion is expected to continue in 2022 with GDP increased by 4.5% and employment levels fully restored to pre-pandemic levels by the middle of next year.

Looking to 2023 and future years, however, the outlook becomes more opaque. The impact of fiscal stimulus will have run its course. There is possibility that inflation may take hold in ways that compel the Federal Reserve to reverse its accommodative monetary policy. Many economists see GDP growth in 2023 falling back to under 2% in the pattern prevalent in the decade before the pandemic.

The Market: Some analysts have called this current period in the stock market as “fun in the sun.”  Companies are starting to report 2Q earnings and the consensus forecast shows a 60% rise in year-over-year S&P 500 earnings per share.  This prognosis explains much of the recent strong performance of the market. Healthy profit growth assuages some of the concern that stocks are overvalued.  The S&P 500 P/E Ratio Forward Estimate is currently 21.70 down from 24.30 one year ago.

But 60% corporate profit growth for the second quarter is a moment in time.  The outlook for full-year 2021 is in the 15% to 20% range. The number then falls to below 10% for 2022 and future years.   This situation then feeds into the fear that some kind of unsettling news will spook the market and send stock prices lower.  This news could include signs that inflation will be persistent not transitory, Congressional action to raise corporate and capital gains taxes, and, worse, resurgence of Covid from the Delta variant.

At Hudson Advisors, we believe it possible the market could grow another 5% to 7% before the end of the year.

We also understand the concerns about a reversal in stock prices. The pullback in early July reflects the market's effort to find direction. On balance, we think it most likely the market will trade in its current range, and we will manage client portfolios in that context.

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