U.S. equity markets continued to push higher this past week as the economic growth outlook lifted further on the back of the strong March employment report and positive service sector data. For the week, the S&P 500 notched its third consecutive weekly gain with a 2.8% return, while the Dow Jones and Nasdaq Composite advanced by 2.0% and 3.1%, respectively. Shares of cyclical stocks leveraged to the economic recovery took a breather last week from their strong year-to-date rally as large technology stocks took the lead after lagging the broader market so far this year. The S&P 500 tech sector gained 4.7% while the energy sector was down -4.0% and real estate and materials eked out gains of 0.6% and 0.7%. Despite rising economic growth and inflation data, interest rates stayed in check with the 10-year Treasury yield ending the week at 1.66%, remaining below the 1.75% level it hit last month.

 

First quarter corporate earnings season will begin picking up steam this week with large banks and financial service companies first on the docket. Given the strong traction in the U.S. economic recovery supported by stimulus and the growing vaccine rollout, the first quarter results are expected to mark strong growth compared to the disruption from the onset of the pandemic in the first quarter of 2020. According to FactSet, the consensus first quarter earnings growth forecast for the S&P 500 constituents is for nearly 25% growth year-over-year. Investors will be listening closely on earnings calls for discussions of supply chain pressures, rising input costs (and ability to pass on those costs), and potential corporate tax reform implications.

 

Although stocks may have the wind at their back from an earnings growth perspective, the robust economic recovery can also pose a bit of a double edged sword for stocks as the need for accommodative monetary policy is reduced. The Federal Reserve’s efforts to maintain low interest rates and easy liquidity to stimulate the economy have also been supportive of expanding stock valuations. As the labor market works its way back toward full employment and economic growth and inflation normalizes, the central bank would be able to gradually withdraw its support, beginning with its bond purchase program meant to keep a lid on long-term rates, including mortgage rates, and eventually increasing short-term rates. Fed members generally don’t anticipate hiking rates until at least 2023 as of their March meeting.

 

However, some market participants are concerned that a significant overheating in economic activity and runaway inflation could force the Fed’s hand in becoming more restrictive sooner than anticipated. March’s inflation readings came in to the upside of expectations with producer and consumer prices (PPI and CPI) rising 3.1% and 2.6% year-over-year, respectively. It’s important to note, however, that these readings, as well as the annual inflation readings over the coming months are skewed to the upside by being compared to economic shock from a year ago that initially sent prices lower. Near-term inflation is heating up as consumer demand supported by stimulus resumes and supply chain disruptions linger, but not to the extent shown by year-over-year numbers.

 

The week ahead will be chock-full of important economic updates in addition to the kick-off of earnings season. U.S. consumers will be the main focus with monthly retail sales announced as well as consumer sentiment data. Additionally, updates on the vaccine front will be watched closely. Daily U.S. vaccinations are tracking over 3 million per day, but U.S. health officials are calling for a pause on administering the Johnson & Johnson vaccine on blood-clot concerns among a small group of recipients.