The economy is expected to boom in the second quarter, and that’s good news for stocks

• The second quarter is often a positive for stocks, said Sam Stovall, chief investment strategist at CFRA.
• This time, the economy is bouncing back from the pandemic, with consumer spending expected to increase at service and hospitality-focused businesses.
• Ethan Harris, Bank of America’s head of global economic research, forecasts economic growth of 10% in the second quarter.

The nation's economic growth is in for a boost in the second quarter, as parts of the economy most impacted by the pandemic reopen.

Never before has the service sector led the U.S. into a recession or so many trillions of dollars in stimulus have been applied.

But with more Americans vaccinated and more states reopening activities, the economy could sizzle as retailers, restaurants, hotels, gyms and other service-oriented businesses see a sudden surge in demand.

The stock market has been trading higher on these expectations for months. However, if the strong activity results in a better earnings outlook, it could further fuel the rally. The S&P 500 was trading at a record high Thursday, crossing 4,000 for the first time as the new quarter began.

"Some of it is factored in, and if there's a risk, it's to the upside rather than the downside," said Sam Stovall, chief investment strategist at CFRA. "From an economic perspective, we could be underestimating and that could end up providing a bit of a boost to the stock market unless interest rates rise even further."

Stovall said the second quarter is often positive for stocks, and the S&P 500 has averaged a 2.8% gain in the quarter since 1990.

Stocks ended the quarter higher nearly two-thirds of the time. The S&P 500 closed out the first quarter with a 5.8% gain.

Booming growth

Economists forecast gross domestic product grew by a median 5.4% for the first quarter, which ended Wednesday. But estimates for the second quarter are much higher and have been rising.

The median growth forecast for second quarter GDP is now 9.3%, according to the CNBC/Moody's Analytics Rapid Update of economists' forecasts.

"The consumer is the big story. It's not just the stimulus bills. … It's the leftover stimulus money that's accumulated in bank accounts," said Ethan Harris, head of global economic research at Bank of America.

The last two Covid relief bills approved by Congress paid individuals $600 in early January and $1,400 in March.

"We think there's $3.5 trillion sitting in bank accounts above and beyond the normal level." said Harris. He said that calculation is based on estimates of what deposits will be once the latest round of stimulus enters the economy, as well as the trend in deposits.

The Conference Board consumer confidence index jumped 19.3 points to 109.7 in March, in one of the largest increases on record. It is the highest confidence level of the pandemic era.

"It's a big blank check for the consumer, depending on how much they want to spend in the next couple of quarters. This quarter, the reopenings should be speeding up, so the deployment of all this liquidity speeds up as well," said Harris.

"The pent-up demand is going to come through pretty fast," he added. "The only thing that's going to put a little sand in the gears in the next month is Covid cases are picking up again."

Harris said the recovery in the next month could be impacted by the increase in Covid cases, but it shouldn't slow the economy much unless hospitalizations start to rise.

He expects June to be the hottest month for the economy, as weather warms and more people are vaccinated.

The economy was hit in the first quarter by unusually cold weather in Texas and elsewhere in the South that caused power outages and shut down energy production.

"That set us back a bit," said Diane Swonk, chief economist at Grant Thornton. "You're going to see the real unleashing of pent-up demand really gain momentum in the second quarter, as more people get vaccinated. It's a little too euphoric."

The second quarter is likely to be the best quarter of the year. "We're getting close to 10% growth," she said.

"The summer will be great, but the second quarter is really where you get the ramp-up and you're just adding onto that," she said. "We're going to have the strongest year since 1984, after the worst year since 1946 when soldiers came back from World War II. The good news is there will be some spending that spills into 2022."

More spending

The recovery in good spending will boost service spending, Swonk said.

Indeed, consumers are starting to travel again.

Weekly hotel occupancy stood at 58.9% for the week of March 14 to March 20, according to data from STR, a research firm covering the hospitality industry.

That's the highest level since early March 2020.

Harris expects economic growth of 10% in the second quarter, followed by 9% in the third. That should taper to 5% by the fourth quarter and then 4% in 2022.

"The question is how much leftover spending power is still driving growth, " he said. "To what degree do people have all this wealth and savings on their balance sheet."

Harris said as the burst of consumer spending begins to wane, business should help the economy maintain momentum. "As you move forward a bit, the investment side starts to become more important," he said. "Business confidence keeps growing as the economy booms."

Stock strategists expect the trajectory for the market is higher, but gains are not expected to be as rapid as they had been.

"You could have the market going up marginally but the multiples going down because the earnings growth is going to outstrip," said Jefferies equity strategist Steven DeSanctis. "You've got all the good news already priced in so you need some incrementally good news, whether that's going to be the earnings coming in better than expected."

DeSanctis said he does expect earnings outlooks to be revised higher.

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