Tailwinds push stock to new highs
There is a lot to be happy about, as U.S. stocks finished a strong 2nd quarter at new highs. The benchmark S&P 500 index advanced 8.55% in the second quarter to close up 15.25% year-to-date.¹ Those double-digit gains reflect a powerful economic rebound propelled by consumers rushing to shop, travel, and eat out after a year of lockdown. Air travel, devastated in 2020, is already back to 80% of pre-pandemic passenger levels and expanding fast. That momentum is expected to continue into the second half of the year, pushing consumer prices and corporate earnings higher, as stocks trade at the steepest valuations in over twenty years.
Consumers feeling flush
It’s no surprise that consumers are spending in a big way. Trillions of dollars of stimulus have been pumped into the economy through the American Rescue Plan, stimulus checks and other initiatives. The Fed is greasing the gears via billions in monthly bond purchases, and consumers have only to look at rising neighborhood home prices and climbing account balances to feel flush. In April, U.S. home prices grew at the fastest rate in 15 years, spurred by low mortgage rates, a dearth of homes for sale, and the on-going migration to more affordable and spacious homes far from city centers. By many measures, household finances are in their best shape in years, meaning the economic expansion still has room to run.
Inflation fears take a step back, but still a concern
Inflation has been the dark cloud on the horizon. While rising prices are still a concern, inflation fears have calmed slightly since March. The Federal Reserve believes inflation is “transitory” and will subside next year as the economy normalizes. The bond market seems to endorse that view, as witnessed by falling 10-year Treasury yields from 1.74% at the end of March to 1.44% by June 30.² Those lower yields reflect expectations that inflation will stay under control and Biden spending proposals will be scaled back by a tight-fisted Congress. Still, as many companies now resort to widespread wage increases to entice reluctant employees back to work, higher labor costs risk cutting into corporate profits or getting passed through to consumers.
Expectations for rising interest rates
At its June meeting the Fed signaled that budding inflation, and the surprisingly strong recovery, might prompt higher interest rates as early as 2023, a year ahead of schedule, or even earlier. Chairman Powell says the Fed will move interest rates off zero once it’s convinced the recovery is on solid ground and there’s progress toward recovering almost 7 million jobs lost in the pandemic. It’s a Catch-22. Higher rates are a sign of confidence in the economy. They benefit conservative savers who have been starved for yield. At the same time, higher rates can deflate corporate profits and jeopardize lofty stock valuations by making alternative investments more attractive.
- Investors should expect bumps along the way as the economy gets back to “normal.” Supply chain disruptions, shortages, and price hikes are inevitable short-term consequences of this powerful recovery. Whether they will stick or not remains to be seen.
- Expect large daily market moves, like those seen in Q2, depending on the day’s economic news. Value and growth stocks have been jockeying for market leadership. Value surged in Q1, led by the strong rebound and higher potential inflation. Growth stocks regained the lead in Q2 as growth and inflation expectations moderated. Diversify your portfolio to include both and ignore the day-to-day news headlines.
- We expect Europe and parts of Asia to play catch up as more people are vaccinated and economies open up. Make sure your portfolio is well-diversified and consider exposure to opportunities overseas, where valuations are more attractive than in the U.S.
- The threat of rising rates has pushed benchmark bond returns slightly negative year-to-date. You can mitigate the risks from higher rates by shortening bond maturities. Short-term bonds have historically been less sensitive to rising rates and may actually benefit as short-term rates adjust upwards.
- While Congress debates the Administration’s ambitious tax proposals, now is an ideal time for investors to take action. Higher capital gains tax rates could lead to more volatility, as those with gains race to lock in sales. Likewise, a rise in corporate tax rates, making companies less profitable, could potentially result in a significant market correction. Strong equity results have pushed many investors’ stock allocations above target levels. Now is the perfect time to right-size your portfolio by rebalancing and reducing over-concentrations in asset classes, sectors, or individual stocks. Your Advisor can guide you on these and other aspects of your wealth management strategy.
1. Data source: Ycharts, Inc.
2. Data source: Ycharts, Inc.