Commentary provided by John Packs, Senior Investment Officer, AIG Retirement Services
Market Performance Snapshot (Week ending June 30 2021 and Year-to-Date)
- Dow Jones Industrial Average®: +4.6% | +12.8%
- S&P 500® Index: +8.2% | +14.4%
- NASDAQ Composite® Index: +9.5% | +12.5%
- Russell 2000® Index: +4.1% | +17.0%
- 10-year U.S. Treasury note yield: 1.47%
- Down 27 basis points from 1.74% on March 31, 2021
- Up 55 basis points from 0.92% on December 31, 2020
- Three best-performing S&P 500 sectors this quarter:
- Information Technology, +11.9%
- Real Estate, +11.2%
- Communications Services, +10.8%
- Three weakest-performing S&P 500 sectors this quarter:
- Utilities, -1.4%
- Consumer Staples, +1.5%
- Materials, +3.6%
Past performance is not a guarantee of future results.
Stocks continue their upward march, as bond yields fall and inflation concerns linger
Equity markets climbed higher in the second quarter, with growth stocks making up some of the ground lost to value stocks in the first quarter. Treasury yields fell in the second quarter after a sharp run-up in the first quarter – this despite inflation data confirming that prices have been rising as the recovery takes hold and demand outpaces supply.
- Stock performance has been positive this year. The broad-based S&P 500 closed at a new high 34 times in the first half of 2021 – one more than the 33 new highs reached in all of 2020. The index is up 14.4% year-to-date and has notched 5 monthly gains in a row.
- Among S&P 500 sectors, Energy has been by far the best performer year-to-date, boosted by rising oil prices, increasing travel, and the potential for growing investment in alternative energy. The sector had a more modest showing in the second quarter, but is still up more than 42% for the year.
- Financials also gained early in the year as interest rates rose; the sector climbed 24.5% in the first half of 2021.
- Real Estate was a consistent performer in both the first and second quarters, up nearly 22% so far this year.
- After rising less than 2% in the first quarter, the Information Technology sector was the best performer of the second quarter, climbing nearly 12%. The Communications Services sector also had a strong second quarter, notching a nearly 11% gain thanks to major names in the category such as Facebook, which was up 18.1% in the second quarter.
- Both Information Technology and Communications Services helped growth stocks recover ground lost to value stocks in the first quarter. While Q1 was heavily influenced by the reflation trade – investors rewarding stocks primed to do well in a growing economy – the second quarter saw some rotation back toward the growth stocks that performed so well in 2020. After lagging other major indices in the first quarter, the tech-heavy NASDAQ Composite delivered the best returns of Q2.
- The large-cap Russell 1000 Growth Index returned 11.7% in the second quarter, while the Russell 1000 Value Index returned 4.7%. However, value is still outpacing growth year-to-date, with the Russell 1000 Value Index up 15.9% in the first half of 2021 and the Russell 1000 Growth Index up 12.6%.
- Interestingly, small-cap stocks are more clearly a value story this year, with the small-cap Russell 2000 Value Index returning 4.2% in the second quarter and 25.8% year-to-date. The Russell 2000 Growth Index returned 3.8% in the second quarter and 8.8% year-to-date.
- The performance of international stock indices has varied in 2021, as virus outbreaks and other factors have led to differing paces of economic recovery around the world. The broad Stoxx Europe 600 Index is largely on par with U.S. indices, up 13.5% year-to-date, while the Shanghai Composite Index is up just 3.4% and Japan’s Nikkei 225 Index has risen 4.9%. Overseas markets that have had a slower recovery may offer opportunities for future growth.
- Commodity prices continued their surge through much of the second quarter, with prices for lumber, copper, and corn (to take a few examples) peaking in May. However, recent weeks have seen many commodity prices slide, with lumber prices tumbling more than 45% in June.
- Markets have been heavily focused on inflation, with price readings throughout the quarter indicating significant increases on a month-over-month basis. However, markets appear to be aligned with the Federal Reserve’s view that surging inflation is a temporary phenomenon driven by the economic recovery and mismatched supply and demand as consumer spending recovers more quickly than damaged supply chains can keep up. In particular, semiconductor shortages have led to surging prices for cars and trucks.
- In addition to focusing on prices, the Federal Reserve is keenly watching the labor market for signs of sustainable economic recovery. While jobless claims have fallen sharply from pandemic highs, they remain elevated, and monthly payroll gains underwhelmed in the spring. As the third quarter started, the official Department of Labor jobs report for June revealed a gain of 850,000 jobs, the largest increase since last August and above market expectations. Wages also rose 3.6% on an annual basis. However, the economy is still about 7 million jobs shy of where it was before the pandemic, indicating more room for improvement.
Uncertainties to watch in the third quarter: inflation, fiscal policy, and virus trajectory
U.S. equities have performed well through the first half of 2021 and bond yields have stabilized. However, investors shouldn’t be lulled into a false sense of security. Several uncertainties related to the U.S. and global economic outlook remain.
- Inflation indicators will be heavily watched throughout the third quarter. Is the inflation evidenced this spring a temporary phenomenon, or does it signal a structural shift that could lead to higher future inflation? Bond prices and yields will indicate whether markets expect inflation and economic growth to continue accelerating or stabilize at sustainable rates.
- Inflation and employment gauges will also influence the Fed’s decisions on interest rates and asset purchases. It appears likely that the Fed will start tapering its $120 billion a month in Treasury and mortgage bond purchases before it increases the Fed Funds rate from its current 0-0.25% range.
- The timing and pace of Fed decisions will be key. In a recent Bank of America Merrill Lynch survey of fund managers, respondents said the biggest current risks to the market are inflation and a so-called “taper tantrum” (in which bond yields move higher quickly in response to the Fed tapering asset purchases).
- Fiscal policy also remains uncertain. Massive government spending over the past 15 months has helped to buoy markets, businesses, and consumer balance sheets. Markets are expecting Congress and the White House to approve further spending in the form of infrastructure and social services investment in the months ahead. If this spending doesn’t materialize, markets could react negatively.
- The flip side of additional federal spending is higher taxes or increased debt. President Biden has proposed tax increases for businesses and higher earners that could have market implications. Higher federal debt could also, at some point, lead to rising interest rates if global investors reduce their appetite for U.S. debt.
- Perhaps the biggest and least predictable risk for markets in the third quarter and beyond is the relationship between virus variants and vaccines. With roughly half the country fully vaccinated, economic life in the United States has mostly returned to normal. However, the rapid spread of the delta virus variant has prompted restrictions in other countries and its path in the U.S. is so far unknown. The ability of current and future vaccines to control virus variants without resorting to restrictions on life and commerce will have profound effects on the economy and markets.
Final thoughts for investors
The Russell small- and large-cap indices, which are rebalanced every June, recently went through a substantial adjustment, as the market capitalizations of many companies rose dramatically from July 2020 to June 2021. In addition, the first half of 2021 has witnessed shifts in market leadership among different equity sectors and styles of assets, as well as significant changes in Treasury yields. Furthermore, the uneven pace of economic recovery across the world has led to variable performance in overseas markets.
Ongoing market uncertainties make it likely that asset gyrations will continue through the next quarter, and many questions remain about inflation and the direction of monetary and fiscal policy. As we enter a new quarter, speak with a financial professional about your long-term goals and how your portfolio is designed to respond to a variety of market conditions.