Q2 Market Perspective

Summary Video: click here (3 minutes)

When writing these quarterly notes, previous messages are always reviewed to evaluate how circumstances have evolved and issues have changed or been resolved. Tracking the ups, downs, and outcomes facilitates learning and provides needed mile markers as we live and invest in a dynamic world. Looking back a year from now, we can all agree, this summer is looking up… even in the midst of a brutal heatwave!

Pandemics have been broadly discussed as a known risk since the globalization best-seller, The World is Flat, by Thomas L. Friedman, was published in the early 2000s (at least). And yet, Covid-19 shocked the world. While it hasn’t yet been eradicated, people, families, and businesses the world over continue to adapt and evolve. Speaking of evolution, did you know that iPhones, Facebook, and Google are not mentioned a single time in The World is Flat? And 2005 was just a moment ago! In the darkest times, it’s important to remember that the collective human spirit is a powerful force – pursuing progress.

The pace of GDP growth for economic recovery is unlike any we have seen in the post-WWII era, which we believe points to the enduring impact. So, while the recovery itself looks different, our core economic themes remain apt, and we continue to monitor their evolution.

• Small cap and value stocks regain their historical position at the top of leaderboard. Small cap has outperformed large cap in the U.S. by 18.95% over the last year. Likewise, value has outperformed growth in the U.S. by 2.41%. International markets offered similar results.
  • U.S. Small Cap (Russell 2000): +4.29% Q2, 17.54%YTD
  • U.S. Stocks (Russell 3000): +8.24% Q2, +15.11% YTD
  • International Stocks (MSCI ex US Index): +5.52% Q2, +9.92% YTD
  • Emerging Markets Stocks (MSCI Emerging Index): +5.73% Q2, +8.74% YTD
  • U.S. Bonds (Bloomberg Barclays Aggregate Index): + 1.83% Q2, -1.60%YTD
• The U.S. debt ballooned significantly, but has declined from its peak. The debt to GDP ratio is 127.5% as of Q1 2021 compared to 64.4% in Q2 2008. The peak (as of now), was 135.6% in Q2 2020. While concerning, it’s imperative to consider this data in context. For comparison, Japan, has a 235% debt to GDP ratio, and our debt service (interest payments) is dramatically lower than in the 80s and 90s due to lower interest rates. We maintain our view that this is a major issue and risk if not handled delicately with a combination of GDP growth, strategic government spending decisions, exports, and continued emphasis of global reserve currency status.
• The U.S. Economy grew 6.4% in Q1, and the Q2 estimate is 7.8%. Pessimists will point out that additional stimulus checks propped up the economy. There is some truth to it, but a bridge to better employment is important for continued recovery. The unemployment rate was 5.9% at the end of June with gains across all major sectors reported by the Bureau of Labor and Statistics. This also improved the debt to GDP ratio from 135.6% to 127.5% in a short period of time.
• International and emerging markets remain important for an investor looking to own the ‘winners’ over time. GDP is projected to grow at a faster rate in emerging and international markets than the U.S. through 2025. GDP and innovation are driven primarily by consumption and investment. Out of the $1.97 trillion spent on research and development around the globe leading up to the Pandemic, $1.4 trillion was spent in Emerging, Pacific, and European countries. Likewise, global population growth is outpacing the U.S., a catalyst for consumption. Further, global supply chains and day-to-day business operations upended by Covid are now benefiting from innovation, and still have significant upside as their countries’ vaccination and immunity rates lag those in the U.S.
• Inflation Part 1: the data doesn’t tell the whole story. Inflation hit 5%, year over year in May, which is the highest seen since before 2008. There are three reasons. First, the stimulus checks dramatically increased the cash moving around the economy. Second, supply chains around the world remain disrupted, so prices naturally increase during periods of reduced availability. Lastly, prices artificially dropped one year ago due to the shutdowns. When comparing year over year numbers after a price decrease, the future number will always be relatively higher. Collectively, the current data points are a tad noisy, so we are watching this one closely. (Lucky you! Stay tuned for more highly-rated (by our moms), in-depth 994 Group commentary on this topic).
• Inflation Part 2: your 994 Group portfolio is already positioned for inflation. Historically, equities offer a good way to beat inflation. Inflation, by definition, is a rise in prices, and companies raise their prices when selling to consumers. So, guess who gets those higher profits? Owners of equities. Furthermore, consider that international markets provide an additional hedge. If inflation is increasing, it means our dollars are buying less, including currencies in other countries, which may benefit your international holdings. Regardless, inflation is always a consideration of a prudent investor, so this is not a surprise. Stay the course and remember: from 1926 to 2018, after the S&P 500® reached new highs, the next 12 months averaged 14.1%.

In conclusion to this quarter’s message, and in every quarter’s message, there are positive and negative influences to consider in the economy and markets. Business cycles, interest rate movement, domestic vs. international markets, and economic dynamics are constantly at a tug of war. This is why we consistently emphasize the concepts of modern portfolio theory – we won’t know when things will pay off, but over time, we expect they will! Even the proverbial bee in the bonnet of these usual phenomena such as a pandemic or other disruption only result in temporary market responses. Let us all hold on to this example of the powers of disciplined, long-term investing based on a comprehensive financial plan. Have a great summer, and please reach out if you have any changes to your financial picture.

Sources: Dimensional.com, Visual Capitalist June 9th “A Global Perspective”, BLS.gov July 2 “The Employment Situation”, Atlanta Federal Reserve Board GDPnow July 2nd, Fred.com “U.S. debt as a percentage of GDP over time,” First Trust CPI watch May 2021

Footnotes:

Small Cap: Smaller capitalization securities involve greater issuer risk than larger capitalization securities, and the markets for such securities may be more volatile and less liquid. Specifically, small capitalization companies may be subject to more volatile market movements than securities of larger, more established companies, both because the securities typically are graded in lower volume and because the issuers typically are more subject to changes in earnings and prospects.

International Equities: Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

Emerging Market Equities: Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Disclosure:
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

Index Disclosures:
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

Index Definitions:
Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index of fixed rate debt securities rated investment grade or higher by Moody’s, Standard & Poor’s, or Fitch rating services. All issues in the index have at least one year to maturity and an outstanding par value of at least $25 million to $1 billion based on the type of security. Indices are not available for direct investment and do not reflect any fees that may be charged.

S&P 500®: The S&P 500® index is an unmanaged index of 500 companies used as a representative sample of the United States economy. The S&P 500® index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

MSCI Ex-US: The MSCI Ex-US index is an unmanaged index used as a representative sample of the global developed economy outside of the United States. The MSCI Ex-US index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charge.

MSCI Emerging Markets: The MSCI Emerging Market index is an unmanaged index used as a representative sample of the global emerging market economy outside of the United States. The MSCI Emerging Market index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charge.

DJIA: is an unmanaged index of 30 companies used as a representative sample of the United States economy. The DJIA index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

The Russell 2000 index is an unmanaged index of the 2000 smallest companies in the Russell 3000 index. The Russell 2000 Index is used as a representative sample of the small companies in United States economy. The Russell 2000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

The Russell 3000 index is an unmanaged index of 3000 companies in the United States. The Russell 3000 Index is used as a representative sample of the United States economy. The Russell 3000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.