In another periodic conversation with clients, CEO Lew Altfest, CFA, CFP®, CPA, PFS, Ph.D., on July 28, 2021, shared his current outlook for the U.S. economy, interest rates, inflation and the stock market as the world slowly emerges from the pandemic. Please scroll down to the bottom of this article for a replay of Lunch with Lew.

The stock market is high and continues to rise, but interest rates have declined recently, and those two moves are certainly inconsistent with each other. The bond market is saying, through the interest rate drop, that there will be a slowdown in the economy, while the stock market disagrees and says the economic outlook is favorable. Something must give. For stocks, prices are most affected by COVID trends and how they affect consumers’ desire to spend. The spread of the Delta variant may have set back consumption enthusiasm but probably will only moderate economic growth somewhat, particularly if President Biden’s government spending program perseveres. If economic growth returns just to pre-COVID levels, stocks have a great chance for a significant downside at some point. In any case, look for more volatility in the stock market going forward. On its own, the economy should begin to normalize, showing slower real growth sometime next year. That may mean 3.5% growth for 2022 for the year overall and a return to 2.5% growth by the end of this year. However, those GDP figures alone will not justify today’s high stock valuations. At Altfest, we will look at the economy further to search for added growth or, alternatively, reductions in growth.

Today, in a services-dominated economy, inflation is more likely to be driven by hikes in wages for workers, although cyclical rises in commodities, particularly oil, still have inflationary relevance. There has been a sharp rise in wages recently due to the shortage of workers. I suspect Biden will encourage this, even if it adds to the inflationary burden. But now, because of continuing COVID, high inflation for an extended period is moderately less likely. Besides, the Federal Reserve would engineer a recession, as Chairman Volcker did in the ‘80s, to prevent a really serious inflationary period.

Going forward, with interest rates as low as they are, it’s easy to project that in the absence of a real slowdown in the U.S., rates will go higher. The question is how rapidly. A steady, moderate yearly increase supported by the Federal Reserve, while a negative, would have little effect on the economy and the stock market, and seems most likely. On balance, in our investments, we are positioned to allow us to participate in any further rise in the U.S. but with some hedging characteristics, so that we can cushion somewhat any decline in the stock market here. At the same time, we hold above-average positions in foreign stocks whose valuations are much lower than in the U.S. We also have brought our risk profile down somewhat by increasing our equity hedges. We expect to add to our cyclical stocks orientation when the economic outlook clears for them.

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