Client Letter 2021 Q2

Q2 2021 Market Results

The stock market has continued its positive momentum with June 30 hitting a new record high for the S&P 500.  For the quarter the S&P 500 was up 8.55% making it 15.25% for the year so far.  International markets were up 5.17% for the quarter and are up 8.83% for the year.  Emerging markets were up 5.05% for the quarter and 7.45% for the year.  Bonds were up 1.83% for the quarter and down -1.60% for the year.  Short treasuries were off -0.05% for the quarter and down -0.10% for the year.  Bonds continue to struggle with the lack of clarity on inflation and the effect on interest rates.  My guess is the next year will present some challenges for bonds, but as we progress through 2022 I expect that situation will improve.

Portfolio Thoughts

Portfolios performed well again in the second quarter.  Tactical portfolios benefitted from exposure to U.S. growth stocks, our positioning into commodities and a nice boost from the Energy Infrastructure investment we added some time ago.  Strategic portfolios performed well but slightly below tactical due mostly to the lack of exposure into commodities and energy infrastructure.  Momentum portfolios slightly outperformed both tactical and strategic as the U.S. focus continues to work.  One indicator of a shift away from the U.S. and towards global investments appears to have been an anomaly, at least for now.  Our Capital Preservation portfolio also had a decent quarter.  All portfolios benefitted from our ongoing rebalancing efforts.

Markets are continuing to respond to, and adjust for, the ongoing recovery from the pandemic.  Although the economy remains not fully healed, the signs of improvement are clear.  I continue to be somewhat concerned about the S&P 500 hitting new all-time highs, even with the economy not yet back to what it was in January 2020, pre-pandemic.  My fear is that some unknown trigger could push the markets into a correction and the not fully recovered economy adding to the reaction.  However, as a forward looking vehicle the market sees the current improvements and is trading based on that expected full recovery.  So far, the market has proven my concerns to not be valid, so we will see if that continues.  In the end, we believe the S&P 500 will end 2021 in positive territory, and unlike last quarter, we are now projecting the S&P to close out 2021 at the 4,400 level.  That is slightly above where it closed out the second quarter.

Q2 2021 Notes

I think the biggest story to tell for the second quarter is the progress made by the U.S. in fighting the COVID-19 pandemic.  While we will miss the 70% vaccination target set by President Biden, we are at about a 50% vaccination rate.  Only three states are not fully open, with the last one expected to open in July.  Newly reported cases, and deaths, are near zero.  Spending time outside the house has become more normal, and it’s starting to feel like the pandemic is almost behind us.  A very noticeable difference from just three months ago.  Obviously, all this can change quickly if we become afflicted with some new variant (i.e. Delta?), but I’m taking the optimistic route until then.  My congratulations and thanks to all the front-line workers who helped make this happen in such a remarkably short time.

Not a whole lot to talk about having occurred in the second quarter.  Politically, both parties are positioning for coming legislation after Congress comes back from summer recess.  On the table right now is an infrastructure bill.  One version includes a large amount of “human infrastructure” spending, which is code for social and transfer payment spending.  Another, which has more bipartisan support, focuses more on what would be referred to as traditional infrastructure spending, including items such as roads, bridges, water supply, airports & marine ports.  Given that parts of our current infrastructure are in bad condition, it’s hard not to support some kind of infrastructure spending plan.  The bipartisan version of the bill is currently looking more likely to move forward, with a likely follow-up bill focusing on the “human infrastructure” components and expected to be passed using the Senate reconciliation process, requiring only a majority 51 votes.  Much of the political talk going on now, and the future timing of these various bills, is positioning for the coming mid-term elections in 2022.  Needless to say, both parties are trying to find ways to ensure they take, or maintain, Congressional majority.

This might be a good time to get into the recent news and conjecture of what is happening to interest rates, and more specifically, inflation.  The news seems full of people talking about rising inflation and the possible damaging effects it could have on our currency and the economy.  I’ve heard plenty of doomsday reports.  From my view, there is no question that inflation is rising, but I am not in the camp of seeing us going back to the 1970’s or early 1980’s type of inflation.  Looking at the fundamental data, the pandemic has created gaps in the supply chain for a variety of end products and the components that go into those end products.  A great example is the shortage of computer chips that is affecting manufacture of everything from automobiles to kitchen appliances.  Whenever gaps in the supply chain exist, shortages of products follow.  The general population is getting back to normal, and they are looking to buy items they may have postponed during the pandemic.  Those people have the money and are ready to buy, but in some cases the products are not on the shelf.  Higher demand than supply leads directly to higher prices.  Hence the recent inflation.  However, since the 2008 Global Financial Crisis (GFC) we have had low inflation in the range of 1.3% to 1.7% per year.  The Federal Reserve (Fed) has a target of 2.0% that they have not been able to reach.  There are structural issues in our country that have kept inflation low.  These pandemic effects will push inflation above the 2.0% target into 2022, but I believe by late 2022 or 2023 we will see inflation back at those lower than 2.0% levels.  So, I agree with the Fed when they say that they believe these inflation effects are “transitory.”  They will be with us for over a year, but then will recede.  Inflation can have an effect on general interest rate levels, and so, we may see higher rates along the way, but those will likely be transitory as well.  Currently the 10-year U.S. Treasury rate is about 1.5% and it hasn’t moved much because of pending inflation.  This suggests to me that bond market, in aggregate, is not concerned about an inflation problem.

As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio.  If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim