The U.S. economy powered forward faster than nearly anyone had expected in the first half of 2021. When we wrote our 2021 Outlook in late 2020, our economic views were significantly more optimistic than consensus forecasts. However, in retrospect, they were not nearly optimistic enough. Our theme was getting back on the road again and powering forward. As the economy accelerates to what may be its best year of growth in decades, power has been converted to speed and we’re moving from highways to raceways.

While speed can be exhilarating, it can also be dangerous. Traffic becomes a test of nerves. Turning a sharp corner creates added stress for drivers. Tires wear and engines can overheat. As we look ahead to the second half of 2021 –  and even into 2022 – we see an economy still on the move before it slowly starts to settle back into normal patterns. 

The overall economic picture remains sound, likely supporting strong profit growth and potential stock market gains. However, the pace of reopening also creates new hazards. Supply chains are stressed, some labor shortages have emerged, inflation is heating up — at least temporarily — and asset prices look expensive compared to historical figures.

Markets are always forward looking, and in LPL Research’s Midyear Outlook 2021: Picking Up Speed, we help you keep your eyes on the road ahead. We focus on the next 6-12 months, when markets may predict which latecomers have the strength to extend their run, and whether there may be new beneficiaries of the global reopening. Smart investors are always looking even further ahead – beyond the next curve, lap, or race. Sound financial advice remains the key to durability. With that in mind, buckle your seatbelt and tune up your portfolio. The next stretch may be a fast one with new risks to navigate, but it’s still just another step toward meeting your long-term financial goals.

Economy

The country’s reopened, and the U.S. economy growth rate may have peaked in the second quarter of 2021. Still, there’s plenty of momentum left to extend above-average growth into 2022. We forecast 6.25-6.75% U.S. gross domestic product (GDP) growth in 2021, which would make this the best year in decades. We continue to watch inflation closely, but believe recent price pressures are transitory and will begin to work their way off gradually later in the year. On average, U.S. expansions since World War II have lasted five years, and much longer over the last few decades. There’s nothing on the horizon to indicate the current expansion can’t reach that mark. 

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Policy

The economy was supported through the pandemic by more than $5 trillion in stimulus measures and extraordinary support from the Federal Reserve (Fed). Policy will take a back seat in 2021 as private sector growth replaces stimulus checks. Tax policy, however, remains a concern. Historically higher personal tax rates have had only a modest impact on markets, but higher corporate taxes would have a direct impact on earnings growth, potentially limiting stock gains.

Stocks

The second year of a bull market is often more challenging than the first, but usually still produces gains. Economic improvement should continue to support S&P 500 Index earnings, which had a stunning first quarter. While valuations remain somewhat elevated, we think they look reasonable after considering still low interest rates and earnings growth potential. Our 2021 year-end S&P 500 fair-value target range of 4,400-4,450 is based on a price-to-earnings ratio (P/E) of 21.5 and our 2022 S&P 500 earnings per share (EPS) forecast of $205. 

Bonds

Inflationary pressure and economic improvement may put additional upward pressure on the 10-year Treasury yield. We continue to see the 10-year yield finishing 2021 in the range of 1.75–2.00%. Such a move would leave core investment-grade bonds near flat over the rest of the year. Nevertheless, bonds can still play an important role in a portfolio as a source of income, and as a diversifier during equity market declines. We’re also closely watching the Fed, which may announce plans to reduce its bond purchases later in the year.