Second Quarter Market Review
Contributed by: Brad Meeks, CFA
The second quarter was kind to investors, as all major global stock indices marched higher, with U.S. markets outpacing their international counterparts. Large cap stocks outperformed small cap stocks, while market leadership favored “growth” over “value,” reversing the style rotation that had largely been in play since last November. S&P 500 sector performance showed real estate investment trusts (+12.4), technology (11.3%), communication services (10.5%), and energy (10.1%) moved higher, while more traditional value sectors like utilities, staples, and industrials trailed behind the broad market. The familiar cast of characters outperformed the S&P 500, with technology firms outperforming, as Google and Facebook both rose 18%, Microsoft was up 15%, while Apple and Amazon were up 12% and 11% respectively.
The current macro trends continue to be a strong force in the equity markets, as a combination of fiscal stimulus, central bank liquidity, and successful vaccine adoption aided in the reopening efforts. Earnings for the quarter handily beat expectations, as reported earnings for the S&P 500 were almost double what analysts anticipated. Much of the uplift in earnings is due to the heavy decline of earnings in the prior year’s quarters, but visibility around the pandemic has improved, as has demand for virtually all goods and services. Commentary from companies has remained optimistic relative to the massive disconnect felt this time last year, with firms citing pent-up consumer demand as the U.S. recovery continues. Businesses have begun returning capital to shareholders in the form of dividends that were halted in midst of the pandemic, while we are starting to see outsized share buyback activity, given the record amount of cash on corporate balance sheets.
Research from investment firm Blackrock showed that the first half of 2021 has been the 18th best start for the S&P 500 since 1926. If history repeats itself, the average return in the back half of the year has averaged just over 6% during this timeframe, albeit with periods of market pullbacks along the way. While we would not be surprised to see markets stall or provide a healthy market decline into the late summer or early fall, we continue to believe the path of least resistance for stock markets is higher. Many research firms believe full year earnings projections are much too low; an example given by Credit Suisse suggests that 2021 earnings per share growth was projected at 21% in early January, however is tracking close to 40% for the full year.
Growth Oriented (Equity) Benchmarks as of 6/30/21
Inflation continues to be one of the most talked about topics over the past few months. Everyone from CEO’s and CFO’s to Federal Reserve Governors are opining on the future of everything from the U.S. dollar to used cars. From a corporate perspective, management teams have cited the deleterious effects of inflation as something to watch, but most have commented they plan to pass on higher input costs to consumers or continuing their heightened cost efficiency/productivity measures to protect profits.
Fixed income markets had a welcome reprieve from a relatively lackluster start to the year, as the 10 year Treasury retreated from 1.75% to 1.35%, pushing bond returns positive for the quarter. The Federal Reserve has maintained their stance that inflation expectations should normalize with any headline price pressures being “transitory” in nature. Headline figures for inflation got the attention of financial markets, as supply chain disruptions, shipping constraints, rising materials costs, and a slowly recovering labor market pushed prices higher. The month of May saw prices increase 5% year over year, the biggest inflation increase since 2008, while core prices (ex-food and energy) rose almost 4%. Given that inflation expectations declined late in May, raw material price declined off their peak May prices, and benchmark interest rates declined, inflation concerns are trending toward the Fed’s messaging.
Income Oriented (Bond) & Cash Benchmarks as of 6/30/21
We’ve come a long way in over a year. It’s estimated that over 50% of all American adults have been vaccinated, and confidence that we are slowly returning to a pre-Covid world are returning. Central bank influence on markets and workers returning to gainful employment are all helping to feed a bullish narrative and provide a fairly resilient backdrop for markets. We for one, are all to happy to embrace this optimistic post-Covid.
Despite the generally positive performance markets have seen year to date, an opposite story can be crafted that keeps us honest and cautious. Concerns surrounding relatively high market valuations and the implications that rising input and labor costs could have on corporate margins could come into play in the back half of the year. It’s also conceivable the market could take a leg down if the corporate, individual, and capital gains tax reform materializes and valuations reset to a new normal. Further, there continues to be robust discussion surrounding the Fed’s ability to safely guide the markets to a soft landing in an environment of less market liquidity as quantitative easing subsides. And lest we forget there is still technically a global pandemic which now has variant strands. To mitigate the possibility that any or several of these elements come to fruition, we will continue to provide our clients with all-weather, globally diversified portfolios that provide the durability needed to help them reach their goals.
As always we wish our clients and friends a safe and happy start to the summer and look forward to connecting with you in person or virtually.