Stoked by trillions of dollars in monetary and fiscal stimulus, pent-up demand from millions of consumers and one of the world’s fastest vaccination campaigns, the US economy is poised for an historic boom. That should support the new bull equity market we’re currently in for another three or four years, according to renowned economist and Bottom Line Personal contributor Allen Sinai, PhD. But Dr. Sinai warns that consumers and ­investors will need to keep an eye on different threats than in the past, including much higher inflation—higher prices everywhere you turn—and higher interest rates that could slow stock gains and turn markets volatile.

Here is what Dr. Sinai forecasts for the rest of this year and beyond….

New Bull…New Threats

Prepare yourself for shock and awe. Over the next 18 months, the economy will grow at a pace we have not seen since 1950–1951, the height of the post-World War II boom, as the full impacts of the federal government’s $5.9 trillion in stimulus money and ultra-easy monetary policy kick in.

In the first quarter of 2021, gross domestic product (GDP) growth jumped 6.4%, allowing the economy to reach its prepandemic size less than one year into the economic expansion. The new bull equity market—which began in March 2020 in anticipation of this ­remarkable economic snapback—completely recovered from the February 2020 bear market and hit new highs in just 126 trading days…and has rocketed up 45% in one year. This is strikingly different from any economic recovery and expansion I’ve analyzed, including the last one, in 2009, when the federal stimulus package was a mere $800 billion. The economy crept along at sub-2% annual growth, and stocks didn’t hit new bull-­market highs for six years.

Given the current robust environment, investors can expect gains from stocks for the rest of this year, but they must be aware of and navigate different risk factors than in the past, including…

Crushing federal debt brought on by the largest stimulus package in US history. In fiscal 2020, the federal government’s deficit was triple that of fiscal 2019, pushing the national debt to a new high of $28 trillion. An economic boom now and the higher tax revenue it produces may dramatically reduce federal debt as it did in the Clinton years in the 1990s. But it is likely that personal and corporate income tax hikes will be needed to pay for the fiscal stimulus and new societal initiatives, which could compromise future economic growth.

Bubbles. Some investment markets are awash in liquidity and speculation such as digital currencies and special purpose acquisition companies (SPACs), a type of backdoor initial public offering (IPO). But I think a blowup in either of these relatively small asset classes is unlikely to derail the bull market.

Weak overseas growth. My growth estimates for the US economy and stock market assume a strong recovery overseas. Like the US, nations around the world are pumping stimulus into economies and administering widescale vaccination programs. I expect the global growth rate to be 6% by the end of 2021 and 4.5% in 2022. Major trading partners such as China, whose economy recovered ahead of ours, are likely to grow 11% and 13% for year-end 2021 and 2022. Even laggards such as Europe should grow GDP by 4% and 3% in the next two years.

But if COVID-19 resurgence spreads beyond India, Brazil and other struggling nations and overseas growth does not materialize, that could hurt the earnings of S&P 500 companies and the US stock market, which derive about 40% of total sales from foreign countries.

Spiking inflation. This is the threat I am most concerned about. In April, US consumer prices posted their sharpest increase in 13 years. The prices of used cars rose by 21% year over year…framing lumber used in home building soared 250%…and corn more than 50%. After two decades of nearly invisible inflation, it suddenly has the potential to become a real scourge for investors. Reason: Inflation makes the economy vulnerable to sharp contractions as consumers become reluctant to make purchases. Also, the Federal ­Reserve typically raises short-term interest rates to slow inflation. Higher interest rates can put the brakes on consumer and corporate spending and are a common cause of recessions. Recently, the Federal Reserve pledged to keep interest rates near zero until 2024.

My take: Inflation will be hotter and more persistent than the Fed forecasts, forcing it to start raising rates by
mid-2022.

WHAT HIGHER INFLATION MEANS FOR YOUR STOCK PORTFOLIO

Intensifying inflation and interest rates won’t be enough to kill this bull market. I don’t think we will see the kind of runaway double-digit inflation of the 1970s or even the 5% inflation of the 1990s…and inflation will be partly contained by new technology adopted during the pandemic. Tens of millions of shoppers, even elderly consumers who resisted smartphones, now routinely use them to find the lowest prices on goods and services.

I think the strongest stock gains in the bull market will span 2020 and 2021. After that, investors should prepare for 5% to 10% annual gains and more volatility.

Important step investors should take: Add inflation hedges to buffer the market’s ups and downs and boost returns. Hedges are assets that have a long history of maintaining or increasing value in inflationary environments, ­including gold, commodities and Treasury ­Inflation-Protected Securities (TIPS).

KEY ECONOMIC MEASURES

Here’s what I expect…

GDP: After a dismal –3.5% GDP rate for 2020, I am forecasting full-year GDP growth of 7.8% in 2021…5.5% in 2022…and 3.7% in 2023. The driving force behind these eye-popping numbers is stimulative monetary and fiscal policies and growth in consumer spending, which accounts for 70% of US GDP. I expect consumer spending to rise 9.5% for 2021 versus a drop of 3.9% last year.

Unemployment: The US should continue to add 250,000 jobs a month, and the labor market will strengthen, especially after early September when eligibility for extended unemployment benefits ends and many people are drawn back into the workforce. That is likely to push down the unemployment rate, recently 6.1%, to 5.2% by the end of 2021 and 4.3% by the end of 2022.

Inflation: As measured by the Consumer Price Index (including food and energy), inflation should spike to near 4% by year-end 2021 over 2020 and remain near 3% for year-end 2022
and 2023.

Oil: I expect prices, recently $67.90 per barrel (WTI), to rise to $75 by year-end 2021…and $82 by the end of 2022.

OUTLOOK FOR STOCKS

I’m forecasting that the Dow Jones Industrial Average will rise to near 37,000 by year-end 2021, up 23.5% for the year. The S&P 500 should hit 4,425, a near 22% increase. These gains will be driven by an incredible 37% surge in S&P 500 corporate profits year-over-year. From an historical perspective, stock valuations are high but not scary high, with a forward price-to-earnings ratio (P/E) of 20 to 21 versus the long-term average of 17. Best stock sectors now…

Consumer discretionary. Even after big run-ups, stocks of leisure/­hospitality/travel firms should do well.

Financials. A strong economy and higher interest rates likely will allow banks to boost profit margins and loan volumes.

Technology. This pricey, high-flying sector may not dominate the market as it has over the past decade. But it should be able to grow fast enough to support its premium valuations, especially in areas that are transforming how we live, work and play, including Internet, AI, robotics and cloud-related companies.

Sectors to avoid: Housing and residential construction. Rising mortgage rates could slow the hot housing market. New-home construction could be hampered by shortages of and higher prices for lumber and other commodities.

OUTLOOK FOR BONDS

I warned about the potential for a deeper bear market in bonds due to a cycle of rising inflation, interest rates and rising yields on long-term US Treasuries, which would reduce bond prices. Well, the bear has awakened. The yield on 10-year Treasuries, which began the year at 0.93% and was 1.62% in May, is likely to jump near 2.5% by year-end 2021 and up to 3.5% by year-end 2022. In response, prices for long-term Treasuries already have plunged 11% through May 31. The overall bond market is likely to have negative or, at best, low single-digit returns this year. It will be difficult for small investors to make money in bonds and bond funds in this environment, let alone keep up with inflation. Consider moving into preferred stocks and blue-chip stocks with solid dividend yields, both of which offer a better risk-versus-reward trade-off in the foreseeable future.