The decline in U.S. bond yields in the face of strong economic and inflation data was the prominent feature of financial markets in Q2 (graph below). Some market participants interpret this bond market behaviour as signaling a relative speedy return to pre-pandemic anemic growth and inflation norms. Inflow into mega-cap technology has picked up as a consequence.

Source: Strategas Research Partners

At this point, there is very little hard data to bolster this view. Real economic data continues to exhibit positive momentum as witnessed by the strong recovery in U.S. employment this past week. European data continues to improve (graphs below) as pandemic induced restriction are eased.

Source: Strategas Research Partners

Despite early signs of cost inflation, corporate earnings expectations continue to rise for 2021 (graph below). Expectations were already high at the beginning of the year when U.S. companies were expected to grow earnings by +23% (almost 4x the long-term average). After a strong Q1 reporting season and continued evidence of economic momentum, this number has increased to almost +37% as we enter the Q2 reporting period.

Source: Strategas Research Partners

Our base case remains that we have yet to see the highs in yields or earnings and that the market recovery will continue to be led by the traditional value sectors. The extreme upward price move in these sectors had attracted huge inflows in the first quarter of this year that left these sectors vulnerable to an overcrowded positioning. Recent ETF flow of funds data seems to indicate that this overcrowded positioning has been corrected for the most part in Q2 (graphs below). This should allow for a resumption in market leadership in the second half of the year.

Source: Strategas Research Partners

Source: Strategas Research Partners

While we expect market returns to remain solid in H2, we are cognizant that from a seasonal perspective we are entering the weakest quarter of the year. In addition, while the positive upward trend of the market remains intact, evidence has been building of a recent loss of underlying momentum (charts below). The new highs recorded by market indices during the past month have been achieved with the participation of far fewer stocks. Investor sentiment indicators are also showing growing investor complacency. This combination of seasonality, market breadth and investor sentiment do suggest that the probability of a mild market correction has increased.

Source: Strategas Research Partners

Source: Strategas Research Partners