The U.S. investment markets continued to defy gravity in the second quarter of the year, closing out the month of June, and the first half of 2021, at record highs. This is the fifth consecutive quarter where U.S. markets posted gains. International stocks also performed well, but not with the same bullish intensity that we have experienced in the US.
Asset Class Index Q2 2021 6/30/2021 YTD
US Large Cap S&P 500 8.55% 15.25%
US Mid Cap S&P MidCap 400 3.64% 17.59%
US Small Cap S&P SmallCap 600 4.51% 23.56%
International Developed MSCI EAFE 5.38% 9.17%
International Emerging MSCI Emerging Markets 5.12% 7.58%
In the bond markets, the rates on longer-term securities jumped from historically low rates to simply low rates. Coupon rates on 10-year Treasury bonds are yielding 1.465%, while 3-month, 6-month and 12-month Treasuries are still sporting barely positive yields. Five-year municipal bonds are yielding, on average, 0.51% a year, while 30-year munis are yielding 1.57% on average.
Five consecutive quarters of gains! All-time highs becoming a routine part of the news cycle! Have the markets banished volatility altogether? Of course, the answer is no. This investment climate is not unprecedented (the late 1990s come to mind), but the current investing climate is clearly far from normal. Stock market investing always comes with a certain amount of risk, even if the risks are sometimes temporarily hidden from view.
In June, there were widespread concerns that the economy was about to experience higher inflation; a 5% single month increase in the Consumer Price Index was the highest jump in 13 years. Investors were startled, to the extent that the U.S. Federal Reserve Board felt compelled to put out a statement saying that it expected the gain in consumer prices to be merely ‘transitory.’ Apparently, investors took the Fed economists at their word; a quick drop in 10-year Treasury yields, when converted to the mathematics of bond market expectations, signals an expected inflation rate of 2% or less. Of course, the biggest current investor in Treasuries (to the tune of $120 billion a month) is the Fed itself, so this may be an example of a government agency fulfilling its own prophecy.
Elsewhere, there does not seem to be any obvious cause for alarm. Hiring and consumer spending are rising, and small business owners’ confidence has bounced back above pandemic lows. Congress is about to pass a stimulative infrastructure bill, and interest rates remain low. Corporate earnings are strong. Coming into the year, the consensus earnings estimate for the S&P 500 was around $165; as we write this the consensus for the next 12 months has reached $200 and is still being raised.
Of course, that does not mean we will not hit some rough patches in the second half of the year. Investor sentiment can be tricky, and bull markets tend to end unexpectedly. The economy continues to struggle with supply chain imbalance, as well as with a historic mismatch between the number of job openings and continued high unemployment. The new variants of COVID-19 are an unknown factor, and eventually the government will have to stop juicing the economy with ever-greater amounts of money. We ought to be able to enjoy the gains we have experienced so far in the year without trying to project them out into the unknown future.
Regardless of short-term market movements, we continue to believe that a diversified portfolio of stocks will produce the best results over the long-term. Since 1960, the S&P 500 has appreciated approximately 70 times, whereas as the Consumer Price Index has increased by only a factor of 9. Historically at least, mainstream equities have functioned as an extremely efficient hedge against inflation, and we believe this is likely to continue.
On February 19th, 2020, the market’s peak prior to the pandemic, the S&P 500 closed at 3,386. It proceeded to decline 34% in 33 days as COVID shutdowns took hold. But even if you had bought the index at that epic top, and were still holding on June 30th of this year, your total return would have been about 28%. We’ve never seen a more vivid demonstration of Peter Lynch’s famous dictum that “The real key to making money in stocks is not to get scared out of them.”
Treasury market rates: https://www.bloomberg.com/markets/rates-bonds