July 2021
US Economy: Reopening boost.
Economic recovery continued in June as state and local governments further unwound Covid-19 restrictions and consumer activity remained robust. Consumer confidence hit 127.3, the highest level since Feb. 2020, while the pace of retail sales (+24% from last June) remained brisk and unemployment fell to 5.8%.
US Stocks: Record highs.
US equities continued to climb on strong earnings growth, but the year-to-date trend of value stocks outperforming growth took a breather in June as interest rates fell on expectations of the Fed tightening monetary policy sooner than anticipated. Tech (+6.4%) and real estate (+4.0%) were the strongest performers.
Foreign Stocks: Dollar headwinds.
A strengthening US dollar was a headwind for non-US equities, which posted modestly positive returns in local currency terms. Russia outpaced the emerging markets on the ongoing rise in oil and raw material prices, and the strong performance of e-commerce companies within the consumer discretionary sector.
Fixed Income: Rates dip again.
US bond yields fell for the 2nd straight month, touching 1.46%, the lowest level since Feb., despite a spike in inflation vs. this time last year. Fed Chair Jerome Powell recently telegraphed less stimulus (Fed tapering bond purchases and raising interest rates in 2023), bolstering the stance that the uptick in inflation will be short-lived.
Real Assets: Real estate shines.
REITs and real estate were top performers in June. In particular, the retail subsector (+34% so far in 2021) has led markets, as brick-and-mortar businesses claw back some customers lost to e-commerce at the height of Covid. The median US single-family home price is up 14.7% since last year, on low mortgage rates and limited supply.
Alternatives: Hedge funds keep pace.
Hedge fund strategies posted returns similar to those of traditional assets. Unsurprisingly, strategies that were long equities performed the best in an environment marked by strong stock markets. In fixed income, absolute return strategies outperformed traditional bond markets during the month.
Equities Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 2.3% | 15.2% | 40.8% |
| U.S. Small Cap | 1.9% | 17.5% | 62.0% |
| U.S. Growth | (6.2%) | 12.7% | 43.0% |
| U.S. Value | (1.1%) | 17.7% | 45.4% |
| Int’l Developed | (1.1%) | 8.8% | 32.4% |
| Emerging Markets | 0.2% | 7.4% | 40.9% |
Fixed Income Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 0.7% | (1.6%) | (0.3%) |
| TIPS | 0.6% | 1.7% | 6.5% |
| U.S. High Yield | 1.4% | 3.7% | 15.6% |
| Int’l Developed | (2.0%) | (6.2%) | 1.9% |
| Emerging Markets | (1.3%) | (0.9%) | 7.7% |
| Tax-Exempt | |||
| Intermediate Munis | 0.1% | 0.3% | 2.3% |
| Munis Broad Mkt | 0.3% | 1.4% | 4.6% |
Non-Traditional Assets Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 1.9% | 21.1% | 45.6% |
| REITs | 2.8% | 21.3% | 32.8% |
| Infrastructure | (1.7%) | 5.4% | 23.2% |
| Hedge Funds | |||
| Absolute Return | 0.7% | 2.6% | 6.7% |
| Overall HF Market | 0.4% | 3.8% | 12.1% |
| Managed Futures | (1.1%) | 6.5% | 12.9% |
Economic Indicators
| JUN-21 | DEC-20 | JUN-20 | |
|---|---|---|---|
| Equity Volatility | 15.8 | 22.8 | 30.4 |
| Implied Inflation | 2.3% | 2.0% | 1.4% |
| Gold Spot $/OZ | $1770 | $1898 | $1781 |
| Oil ($/BBL) | $75 | $52 | $41 |
| U.S. Dollar Index | 112.2 | 111.6 | 120.8 |
Our Take
A preponderance of data point to an economic expansion that’s likely to continue through 2021. The tailwinds include a healthier and more confident US consumer and additional government spending, via the use of unspent stimulus and the infrastructure plan now being negotiated. That said, there remain risks to the economy and financial markets related to Covid-19, coupled with relatively pricy equity valuations and the potential for higher inflation and interest rates.
With regard to Covid, the US is now among the most vaccinated countries, despite stumbling out of the starting block. Still, vaccine demand has plateaued and achieving herd immunity appears to be unlikely, with surveys suggesting that the majority who intend to get vaccinated have started the process. This indicates that for the foreseeable future, we will be living life managing the virus as a controllable threat. To that end, the Delta variant that has started to dominate new cases here and abroad bears watching, as it may hinder reopening.
The focus for investors remains on the inflationary potential of rapid growth, which is starting to appear in the data. While inflation has recently accelerated by many measures, there are indications that the spike is potentially shorter-term, including: (1) Base effects, in that prices are up but that’s relative to the Covid-induced lockdown period; (2) Shortages in goods and materials that stem partly from changes to global supply chains are slowly being resolved; and (3) US worker shortages could evaporate by year-end as more people take new jobs or go back to old ones.
At this point, inflation may remain elevated as these factors subside, and we continue to monitor signs of a sustainable, problematic rise in prices. US interest rates are also likely to resume rising, as the Fed has indicated slightly more urgency in preventing inflation and looks to taper the billions in bond purchases it makes monthly.
What We’re Doing
We continue to look for ways to improve diversification and to mitigate potential risks, including a rise in tax rates and inflation. On the latter, our goal is to seek some inflation protection while targeting attractive risk-reward opportunities. We believe we have that combination, including our positions in infrastructure equities, which should provide a buffer against inflation and currently trade at relatively cheap valuations.
It is possible that fixed income will be less effective as a diversifier as the price correlation between stocks and bonds has been rising. In fact, part of the rationale for the current high valuations for equities rests on interest rates being low. What this means is that bonds may not provide as much downside protection as in the past should rising interest rates cause a market downturn. Fixed income will likely still provide needed diversification, but other income-producing assets might be required to keep portfolios in line with risk and return targets.
