In the first half of 2021, investors saw the reopening of many world economies, experienced modest volatility in equity markets, and ended the second quarter that produced many new highs.
The S&P 500 has now gained ground for five quarters in a row at a pace not seen since 1954. Interestingly enough, that was also a time when the Fed was also trying to emerge from a period of ultralow interest rates. Despite the whirlwind of change and volatility that ensued over the last 18 months, investors that stayed the course participated in the economic and financial recovery.
Historically, positive first halves of the year are usually followed by positive second halves. When there has been a double-digit gain in the first half of the year, both the S&P 500 and the DJIA have never ended the year with an annual decline according to Refinitiv data dating back to 1950. (Source: www.cnbc.com 06/29/2021)
However, amidst all the positive momentum toward recovery, there is still concern about the condition of the job market, inflation, and uncertainty about the path of the virus and the severity or impact that new strains may have. Theoretically speaking, the stock market tends to be a forward-looking mechanism, so its price can reflect an economic recovery well before it actually occurs. With COVID variants and many potential challenges still ahead, investors need to continue being watchful.
US AND GLOBAL ECONOMY
The decline in the rate of unemployment in the U.S. slowed drastically from prior quarters with the rate ending the quarter just down 0.1% to 5.9%. This troubled many economists as the rate is still well above the pre-pandemic low of 3.5%. Job openings as referenced by the JOLTS (Job Openings and Labor Turnover Survey) increased by over 11% for the quarter to 9.2 million jobs. This is the all-time high since the index started tracking job openings in 2000. The number of job openings nearly matches the total U.S. employed workforce of 9.48 million.
Many critics have blamed the rise in job openings (especially in the hospitality sector) on the supplemental unemployment benefits that are in effect until September. Others have blamed an increase in the mismatch of workers’ skills to the needs of employers as the root cause. We will need to pay attention to the trend in unemployment in the quarters ahead to not only determine which dynamic is taking effect but also confirm if the labor market continues its path toward a more noticeable improvement.
New housing starts dropped by 9% from the start of the quarter as of 5/31/2021. The drastic rise in material and labor costs is the primary culprit. Existing homes sales also dropped 3.5% in concert with housings starts. Inflation concerns combined with higher rates at the start of the quarter deterred many would-be buyers.
Global Economic activity as measured by the manufacturing and services Purchasing Managers’ Index expanded for most economies during the quarter. The U.S. and Germany led the growth in developed economies for the quarter while Russia and China-led economic momentum for emerging markets. However, developed markets continued to outpace the economic expansion of emerging market economies from the prior quarter. Many attribute this discrepancy to the weaker management of vaccine rollouts as well as the reemergence of COVID variants in emerging markets of India and Brazil.
INTEREST RATES AND INFLATION
The two topics that were on most investors' minds at the end of the 2nd quarter were inflation and interest rates.
In June, the Federal Reserve held their two-day meeting and concluded that due to more aggressive inflation than expected this year, they anticipate raising interest rates sooner than previously expected. Back in March 2021, the Fed expected not to raise rates until at the earliest, 2024. At its June meeting, the Fed’s projections moved the timeline to potentially 2023, where there could possibly be two interest rate hikes. The inflation expectation for 2021 was raised to 3.4%. Back in March, the Fed had anticipated a 2.4% inflation rate. However, Fed Chair Jerome Powell reinforced the Fed’s sentiment that inflation pressures for the year are more “transitory.”
This sent mixed signals to the market as there was much inflation data to support the argument that inflation is running at a hotter than expected pace which could justify the Fed’s action to move rates earlier. On the other hand, some inflation gauges are confirming that supply chain disruptions and the restart of the economy have been the root cause of the inflation spike seen over the past twelve months.
During the quarter, the Consumer Price Index, a prominent benchmark for US inflation, registered a 4.2% year-over-year increase. This is a figure that is well above the Fed’s 2% long-term target. Food prices, energy costs as well as most building materials experienced significant increases for both the quarter and year. This has brought about some concern that the U.S. could be on a path to sustainably higher inflation which has the potential to erode economic growth in the long run.
But when looking at the rapid ascent and decline of lumber prices for the quarter, the transitory argument for inflation is supported. After increasing over 60% from the start of April, lumber prices declined almost by 58% from their May 7th high bringing prices back to where they started the year. With many lumber mills slowly coming back online after being shuttered during the pandemic and new home construction and renovation projects picking up during the spring, this created an artificial supply shock to the lumber market. As mills increased output to meet the staggering demand, the market normalized causing prices to revert closer to their long-term averages.
We are keeping a close watch on the inflation data to see if additional supply and demand shocks are contributing to inflation temporarily or if there is in fact a trend is on a sustainably higher path.
U.S. stocks posted second-quarter gains that were comparable to first-quarter results delivering strong gains in aggregate for all major indexes in the first half of the year. The gradual decline in interest rates was supportive of markets as investors were less fearful that inflationary pressures would cause the Fed to consider raising rates earlier than the original 2023-time frame.
Stocks remained relatively expensive by most historical valuation metrics. However, the stellar growth in first-quarter earnings along with the expectation for a 65% year-over-year growth in second-quarter earnings have helped to justify price levels.
U.S. large-cap stocks outperformed their cyclically sensitive small-cap peers reversing the trend seen in the prior quarter. The same trend reversal was seen across growth stocks which outpaced economically sensitive value stocks. Many value-oriented sectors such as basic materials, industrials, and financials lost momentum to the growth-oriented sectors of technology and communications services which make up a large sizeable percentage of the broad U.S. equity markets. This rotation in leadership can be attributed to waning sentiment for many of the “reopening trades” that were popular in the 1st quarter. With the effects of the vaccine rollout, as well as the acceleration of the economic recovery, becoming fully priced into the market, investors shifted their focus back toward many of the traditional growth themes that lagged the broad market since the November elections.
Both international and emerging market stocks continued to lag U.S. markets for the quarter by a sizeable margin. The U.S.’s success in vaccine rollout has allowed it to restart its economy in advance of many developed and emerging market economies. To date, the U.S. has had a more sustainable recovery which has not been hindered by many of the COVID variants that have caused many other economic recoveries to stall.
FIXED INCOME MARKETS
U.S. Bonds gained nominally for the quarter recovering most of their loss incurred at the start of the year. The U.S. 10-year treasury started April toward the 1-year high at 1.74% and ended June slightly below 1.5%.
Despite the yield decline, U.S. bonds remain the most attractively yielding credit in the world given that most other developed markets are still stuck with rates barely above and in some cases slightly below 0%. During periods of rising rates, it is expected that bond prices will fall. However, as past business cycles have shown us, it is very difficult to determine if the direction of rates will continue or when they will shift. This is why it is important for bond investors to always maintain some level of interest rate sensitivity in creating a balanced and diversified portfolio.
With the swift distribution of vaccines and the subsequent lifting of restrictions, the US economy is seeing a dramatic uptick and is positioned to recover even more in the coming months. While equity markets are still looking favorable, there are still a number of risks that can contribute to volatility for the remainder of the year.
Although history is just data and cannot predict the future, as mentioned earlier, historically a positive first half of the year has traditionally been followed by a positive second half.
Second-quarter earnings will be in focus over the next two months, and it will be important to see if companies manage to deliver revenue and earnings figures that can support current market prices. Also, we will be paying attention to earnings revisions and company guidance to reaffirm the sustainability of the economic recovery.
Higher inflation is of course a primary concern for equity valuations and will determine if the Fed remains accommodative to capital markets. Even if the Fed may have to moderate rates by 0.25% to 0.5% in 2023 or even 2022 as some economists are now projecting, interest rates will most likely stay near historic lows for the near term. Although this lower rate environment can be challenging for cash and fixed income investments it has tended to favor equity markets. This is why we continue to maintain the stance of overweighting stocks relative to bonds.
Investors understand that it is not what you make, but what you keep, so another area we will be paying careful attention to is the proposed new tax policy. With interest rates still near ultra-low levels, investors need to examine the use of equities in their portfolios. With equities at or near all-time highs, investors need to fully understand their personal timelines and risk appetites.
QUARTERLY FINANCIAL PLANNING TIP
Have you ever worried, that if you invest your cash now and the market takes a dip, you might experience buyer's remorse? If you're like most investors, this very well may have crossed your mind.
Since cash rarely outperforms other asset classes because it doesn’t generate any income, especially in a low (or zero) interest rate environment. we have a financial planning tip that you may want to look into.
Given that stocks are trading at much higher levels than a year ago, many investors hesitate to invest for fear that markets could correct after they initiate their purchase. A good tool to help combat the emotional stress of investing new cash and to provide for more investment opportunities is the strategy of Dollar-Cost Averaging (DCA).
Dollar-Cost Averaging is a strategy in which an investor divides the total amount of cash that they have targeted for their investment across periodic purchases of stocks to reduce the volatility of their overall purchase. In order to be effective, the purchases should occur regardless of the assets price and at regular intervals. Although this strategy is designed to remove the peril of timing the market at a single point in time, it does provide investors with the ability to accelerate their future purchases in the event the market does correct to an attractive price level.
DCA strategies tend to work best in declining or choppy markets as investors have more opportunities to make their allotted purchases at lower prices. Of course, rising markets will work against a DCA plan as subsequent purchases are done at higher prices.
If you are considering new stock investments and are feeling hesitant about investing all your money at one time DCA strategy may be appropriate for you. Your DCA strategy should be designed to account for your investment objective as well as your willingness to assume the risk. Of course, it is always best to consult with your advisor so that a personalized DCA plan can be crafted to meet your specific needs.
DISCUSS YOUR CONCERNS WITH US
Whether you are seeking tax strategies, estate planning, or a financial plan, our advice is not one-size-fits-all. We are ready to provide you with financial solutions to achieve a better retirement. We will always consider your feelings about risk and the markets and review your unique financial situation when making any recommendation.