Can the Rally Continue?

Stocks continue to defy the skeptics, pushing the broad indexes into record territory. But persistent 'correction' chatter isn't going away either, keeping alive questions about the market's next move.

I am adding to that debate in this piece by pointing out a source of support for the market that will help the rally gain strength and longevity.

Stocks need power to push higher, just as humans and machines do. For stocks, this 'power' comes from a variety of sources, but interest rates and corporate profits are the biggest drivers.

Interest rates have been market-friendly for the last many years, with forceful Fed action during the pandemic cementing that role. Some inflation worries entered the discourse this year as the Biden administration’s expansive policy platform took shape. This caused long-term treasury yields to modestly move up recently, though they still remain extremely low by historical standards.

Inflation fears aren’t new; they have come and gone regularly over the last many years, particularly since the global financial crisis. There are valid fundamental arguments that suggest that the ongoing version will likely be no different.

This doesn’t mean that we outright dismiss all inflation talk, but it does mean that we can have full confidence in the Fed’s ‘pricing-pressures-are-transitory’ outlook, which should keep interest rates low for an extended period.

Unlike interest rates, the earnings picture took a severe beating as a result of the pandemic, with activities related to the broader leisure, hospitality and travel spaces particularly hard hit.

Widespread vaccinations have materially brightened the outlook for these activities domestically, though our recent experience with the Delta variant has added some uncertainty to the outlook.

The much bigger uncertainty is about regions beyond the U.S. borders that have far smaller proportions of their populations immunized and are forced to institute fresh restrictions in the face of new outbreaks. The concern is that these outbreaks come in the way of the expected global economic rebound and serve as a brake on the accelerating earnings growth outlook.

Earnings growth remains very strong, with the ongoing 2021 Q3 earnings season on track to show growth in excess +35%, with the last quarter of the year expected to show growth in excess of +21%. This growth pace represents a deceleration from the first half’s breakneck speed, but it is still very strong by historical standards. This would come after the COVID-19-driven declines of 2020 when earnings dropped by -13%.

Continued . . .

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Zacks Investment Research

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Written By: Zacks Investment Research