After an already strong start to the year, U.S. equity markets continued to post solid returns in the second quarter, thanks to the ongoing global vaccine rollout combined with fiscal support from the government. The S&P 500, a benchmark for large capitalization domestic companies, gained 8.6% for the quarter and was up 15.3% at the halfway point of the year. All market sectors posted gains for the quarter, except utilities. Growth-oriented sectors such as communication services and information technology led the upward move and energy also remained strong as result of the continued rally in oil prices. Real estate led the pack amid an improving rental outlook and the market’s search for yield. Economically sensitive cyclical sectors such as industrials and materials lagged, as did the more defensive utilities and consumer staples sectors. Small capitalization stocks maintained the top spot for year-to-date performance with a 17.5% return posted by the Russell 2000 Index.
The international markets had a slower start to the quarter due to various delays in vaccine distribution which resulted in slower reopening of some economies, but they have shown tremendous improvement in the last month. The emerging markets lagged the developed ones due to tougher obstacles and higher COVID-19 case rates.
The U.S. bond market made up some of the losses it experienced in the beginning of the year as the decline in interest rates was positive for returns. The Bloomberg Barclays U.S. Aggregate Bond Index, a proxy for the investment grade bond market, increased by almost 2%. Other areas of the fixed income market (corporate, high yield and municipal bonds) also posted positive returns.
The strong economic recovery continued with annualized GDP growth of 6.4% in the first quarter. This increase reflected a rise in personal consumption and federal, state, and local government spending. Analysts now see the economy expanding about 9% in the second quarter as the recovery continues, although rising price pressures are already weighing on some sectors. This remarkable growth, if achieved, would elevate our real GDP above the pre-pandemic peak of December 2019 but remains below the 2.5% growth rate trend of the last few years.
After falling in April and May, hiring accelerated in June as businesses tried to keep up with a rapidly recovering economy. Job gains were led by the leisure and hospitality industries which suffered the steepest losses last year. Average hourly earnings also increased amidst the worker shortage.
The net worth of U.S. households climbed to new highs in the first half of 2021, and the increase in housing values has driven the steepest year-over-year appreciation since the end of the last century. Prices were driven up by low mortgage rates, a surge in demand and the shortage of homes for sale.
The strength of the economy’s and job market’s rebound drove the biggest surge in inflation in nearly 13 years, with consumer prices rising by 5% in May compared to one year ago, the largest increase since June 1992. The higher-than-expected inflation data has fueled the speculation that the Federal Reserve could take some steps back from its accommodative stance. After the meeting in June, the Chairman of the Fed, Jerome Powell, acknowledged that higher inflation was expected for the remainder of 2021 and that interest rates may have to be increased on an earlier timeline. However, he also stated that the inflation we are witnessing now is “transitionary”, temporary in nature, and the price pressure will subside as the year progresses.
As we move into the second half of 2021 there are competing forces that can move the markets in opposite directions; corporate fundamentals and a strengthening economy on one hand, and a mutant Covid virus on the other. The U.S. economy is coming back strong, but so is the Covid virus. Americans need to get together to stop this virus in its tracks. With American ingenuity and knowledge, we believe they will. We do not believe the government will put the U.S. economy into an induced coma as they did last year. Given the strength of companies’ earnings and forward guidance we believe fundamentals will remain solid as the economy continues to be driven by the renewed activity of the quite healthy U.S consumer, thereby supporting continued market expansion. This does not mean the market will not, at times, face some difficulties. Corrections should be expected as the market moves higher. While these corrections are rarely smooth and steady, they are the reason investors demand and receive higher returns over other financial assets.
In conclusion, we believe the market will be choppy for the rest of the year but end 2021 with above average returns.
Dumont & Blake Investment Advisors, LLC
June 30, 2021