Recently the term “peak growth” has been mentioned frequently by professional investors and media alike. Peak growth is defined as the time when Gross Domestic Product (GDP) is the point of the highest growth rate where the subsequent growth rates are lower in the following quarters. The deceleration of growth doesn’t necessarily mean negative growth but slower growth than the peak.
The reason investors worry about peak growth is because it is a signal the economy is slowing and may move into negative growth, or recession, territory. On an annual basis, the chart below (right side) reflects that the estimated GDP growth rate will peak this year at around 6% and is expected to slow afterward. The timing of the peak growth quarter is still in question, with estimates pointing to the third quarter of 2021 (below chart, left side). Whether the peak growth quarter is in the second or third quarter of 2021, forward estimates have growth slowing in the following quarters. While both reflect slowing growth from peak levels, neither chart currently estimates a recession in the near term.
The reason investors have a fear of peak growth is that a growing economy is a beneficiary for most, if not all, asset classes. In a strong stock market, as we have seen since March 2020, investors worry that future growth will be lower and so asset valuations should reduce as a result. Peak growth, however, does not mean the economy collapses but simply slows from a higher growth rate. During market expansions, there have been several peak growth quarters followed by lower growth quarters, and the stock market continues to move higher. In the chart below, the time periods in the gold circles show periods of slower GDP growth (red arrow) after peak growth and the stock market (green arrow) continues to move higher.
If the rate of economic expansion remains positive, even after peak growth, stocks generally appreciate. There may be rotation among sectors and stocks as the growth rate of GDP changes but historically the general direction of the stock market has been higher. In our opinion, sustained economic growth where economic conditions remain positive is the more important fundamental indicator for the health of the stock market.
Investors have a fear that a peak in the economic growth rate also means a peak for the stock market. Historically, this has not been proven as accurate. Peak growth is just a point in time marking the most recent high GDP growth rate but there are many other factors that determine the future direction of the stock market.
At Gradient, we rely on fundamental factors such as growth of company earnings and valuation along with where we are in the economic cycle, to make determinations on individual stocks and asset allocations. Our current estimate is that sustained economic growth is possible as we recover from the pandemic and the US consumer is healthy and willing to spend. While peak growth may be happening right now, sustained growth could carry the market higher over the next several years.