Q2 2021 Market Commentary + Outlook

This quarter, Aldrich Wealth Partner Nicole Rice is joined by Director of Investments, Chris Van Dyke to provide market commentary and make projections for the upcoming quarter. This conversation is accompanied by a deeper dive into market performance and outlook, as well as popular topics such as changes in interest rates

The S&P 500 climbed 8.6% over the second quarter of 2021 on the strength of the economic reopening, rapid COVID-19 vaccine rollout, and news of a bipartisan infrastructure deal. Growth outpaced value and large-cap stocks bested small-cap stocks. Overseas, the MSCI EAFE Index rose 5.2%, and the MSCI Emerging Markets Index added 5.1%. In fixed-income markets, the Bloomberg Barclays US Aggregate Index added 1.8%, as the yield on the 10-year US Treasury fell slightly. US gross domestic product (GDP) increased at an annualized rate of 6.4% in the first quarter of 2021 and is forecast to increase 7% over 2021, which marks the greatest pace of growth for the US economy in nearly four decades. Although inflation has captured headlines, increases in the price level appear to be transitory.

The S&P 500 rose 8.6% during the second quarter of 2021, as investors cheered the reopening of the economy and COVID-19 vaccine distribution efforts. Yearly returns for the large-cap index now stand at 15.3%. Ten of the 11 underlying sectors put in positive showings for the quarter, with utilities dimming slightly. Following two consecutive quarters of underperformance, growth stocks bested value stocks. Information technology and communication services, conventional growth sectors, posted strong returns for the quarter. After losing a third of its value in 2020, the energy sector has come roaring back in 2021, rising in tandem with oil prices. Energy has jumped 45.6% over the first half of the year. Notably, the top-performing for the second quarter was real estate, which rose 13.1%. Investors have taken shelter in the sector in anticipation of rising inflation and interest rates. Finally, large-cap stocks bested small-cap stocks.

International stocks were outpaced by their domestic peers. The MSCI EAFE Index of international developed stocks rose 5.2% over the quarter. In Japan, where just 14% of the population has been fully vaccinated against the novel coronavirus, equities dropped .3%. Ahead of hosting the Summer Olympics, Japan has debated extending a “quasi” state of emergency in Tokyo to limit the spread of COVID-19. The MSCI Emerging Markets Index rose 5.1%. China, the largest weighting within the Index, is off to a slow start in the first half of 2021, having risen just 1.8% on the year. Chinese regulators continued their general crackdown on technology companies in the second quarter of the year. More specifically, regulators levied a record $2.8 billion fine on Alibaba for abusing its dominant market position.

The Bloomberg Barclays US Aggregate Index rose 1.8% for the quarter, while the broader Bloomberg Barclays US Universal Index rose 2%. On the year, the Aggregate Index is down 1.6%. The yield on the 10-year US Treasury dropped 29 bps over the quarter, starting at 1.74% and ending at 1.45%. Note that bond prices increase as yields fall. Virtually all asset classes within fixed income rose for the quarter. After dropping 7.2% over the first quarter of the year, emerging-market bonds rebounded in the second, returning 4.4%. High-yield bonds, the top-performing asset class within fixed income for the year, rose 2.8% over the quarter. Year-to-date returns for high-yield bonds stand at 3.7%.

Over the first quarter of 2021, the latest period for which data is available, US GDP increased at an annualized rate of 6.4%. In June, the Federal Reserve estimated US GDP will grow 7% in 2021. A 7% increase in GDP would represent the greatest year-over-year economic growth for the US since 1983 when GDP grew by 7.9%.

The unemployment rate has ticked down over the first six months of the year, coming in at 5.9% for June. The Fed estimates the unemployment rate will fall to 4.5% by the end of 2021.

The consumer price index (CPI) rose 5% year-over-year in May, its largest increase since August 2008. Core CPI, which removes inflation in volatile food and energy prices, rose 3.8% year-over-year in May, its largest increase since June 1992. Despite the sizable jumps in headline inflation, the Fed maintains that price increases will prove to be transitory rather than permanent. An under-the-hood look at the components of CPI seems to validate this thinking from the Fed. For example, roughly one-third of the 5% increase in year-over-year CPI in May was attributed to a rise in the price of used cars and trucks, which are up 29.7% year-over-year. Similarly, airline fares rose 24% year-over-year in May.

Stepping back, the 5% year-over-year increase in CPI reported for May appears to be indicative of an issue with “base effects.” Economic activity was highly restricted in May 2020, at which point the US was in the throes of the COVID-19 pandemic. In short, the low base from which year-over-year inflation is now being measured is a result in exaggerated readings that are not representative of long-term CPI trends.

Although the Fed maintains inflation will be short-lived, Fed officials still signaled in June that they anticipate lifting the federal funds rate to .6% by the end of 2023. The federal funds rate target was lowered to 0-25 bps in March 2020 and has been held there since. The effective federal funds rate as of June was .08%. For now, the Fed has committed to continuing its monthly purchases of at least $120 billion of Treasury bonds and mortgage-backed securities, as it has since June 2020. In June 2021, however, Fed Chairman Jerome Powell indicated that the Fed is now “talking about tapering” these purchases.

After a tumultuous 2020, the United States and much of the developed world are rapidly recovering and eyeing a return to normalcy. So far, 47% of the US has been fully vaccinated against COVID-19, with 55% of the population having received at least one COVID-19 vaccine dose. 99 doses per 100 people have been administered in the US. After getting off to a sluggish start with its vaccine rollout, Europe is now catching up with the US. To date, 71 doses per 100 people have been administered in Europe. Figures are even more impressive in the United Kingdom, where 118 doses have been administered per 100 people.

Throughout the COVID-19 crisis, expansionary fiscal and monetary policy within the US and abroad has been extremely accommodative. Continuing with this theme, in late June, President Joe Biden and a group of ten centrist senators agreed to a roughly $1 trillion infrastructure plan that would revamp the US electrical grid, bridges, and roads. By and large, record-breaking stimulus packages have succeeded in their mission of carrying the US through the crisis.

US GDP is forecast to grow at a rate of 7% in 2021, its highest level of growth in nearly four decades. Although a record number of job openings exist within the US, unemployment is low at 5.9% and is expected to fall to near full-employment levels of 4.5% by year-end. Inflation concerns have caught the attention of investors, but the Fed maintains that increases in the price level will be transitory. Much to the satisfaction of markets, the Fed has kept the fed funds rate at historic lows and looks to not taper bond purchases until the economy achieves maximum employment and inflation runs consistently above its target.

Against this backdrop of economic expansion, value stocks are poised for strong performance. Not only are value stocks attractively priced relative to their long-term averages, but they also have return profiles correlated to GDP. That said, we still prefer to equal weight value stocks and growth stocks, which, as suggested by their name, offer strong long-term growth prospects.

Year-to-date, the MSCI EAFE, and MSCI Emerging Markets indices have lagged the S&P 500. Still, past performance is not indicative of future returns, and international stocks are trading at historically significant discounts to their domestic counterparts.

In fixed income, bond yields are near all-time lows, with the yield on the 10-year US Treasury ending the second quarter at 1.45%. Still, pockets of opportunities exist within fixed income. We favor managers with broad investment mandates and asset classes that exhibit little correlation with traditional bonds.