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As America continued to recover from the COVID-19 pandemic in the first half of 2021, the economy and the equity markets made significant progress during the second quarter. By the end of the first quarter, U.S. GDP had already rebounded to within 1% of its pre-pandemic peak. Given what has been a strong second quarter, it’s likely the data will show the U.S. economy eclipsed its previous all-time high by the end of the second quarter. This dramatic recovery was spurred by three factors: 1) Widespread vaccine availability and the pandemic’s retreat, perhaps more so here in the US than anywhere else; 2) continuing and unprecedented monetary and fiscal stimulus; and 3) The economy’s own fundamental and inherent resiliency.
In market activity, the S&P 500 closed the quarter at 4319, returning 8.55% for the quarter. Developed international markets posted returns of 5.17%, and emerging markets, 5.05% (both in U.S. dollar terms). Although large, growthier companies outperformed in the second quarter, perhaps due to increasing concerns about the more contagious COVID Delta variant, value and small stocks handily outperformed larger growth companies over the entirety of the first half of the year. Despite concerns about inflation, most major bond indices posted positive returns for the quarter, with the Bloomberg Barclay’s U.S. Aggregate Bond Index up 1.83%.
More broadly, the economy continued its resurgence. At the start of 2021, the consensus earnings estimate for the S&P was $165. Today, it stands at $200, with expectations continuing to increase. Perhaps, the most encouraging economic report this year was just released in the last two weeks. US household net worth rose 3.8% in the first quarter, propelled by broad gains in the equity and housing markets. Equally important, the ratio of household debt to assets has continued to fall, now at an almost 50-year low. In June, the National Retail Foundation raised its outlook yet again with expectations that year over year retail sales will increase by 13.5%, up from the previously estimated 10.5%. And, just this past month, the retail giant Target raised its dividend by a whopping 32%.
This good news came despite the economy continuing to struggle with supply chain imbalances and a historic mismatch between the number of job openings available and continued high, though rapidly declining, unemployment. The possibility remains that the unprecedented experiment in monetary and fiscal support has overstimulated the economy, with May’s year-over-year inflation print coming in at 5%. This is the largest annual jump since 2008, but it’s worth remembering that last May provides an unusually low starting point due to last year’s shutdown, making questionable the usefulness of the comparison.
While inflation is a concern—and probably a larger one for anyone old enough to remember the 1970s, there are substantial differences between then and now. One key difference: a substantial component of the inflation we are presently seeing is undoubtedly related to supply chain issues as our economy emerges from its lockdown-induced coma. Many of these issues should resolve as other countries’ economies do likewise and supply chains normalize. There are already signs that this is happening, with lumber prices down 50% from their all-time highs as bottlenecks cleared up, although they are still considerably higher than they were a year ago.
Furthermore, today’s inflation rate, especially given these unusual circumstances, tells us very little about what next quarter’s or next year’s inflation rate may be. Two researchers at the Peterson Institute for International Economics, a non-partisan Washington think tank, analyzed how accurate economists and consumers had historically been at predicting inflation. Their conclusion? Not very. Just as is true with interest rates, oil prices, and stock markets, predicting future inflation looks to be a fool’s errand.
Lastly, on the inflation topic, Federal Reserve Chairman Jerome Powell and a majority of the June meeting participants appear keenly aware of the inflation risk, with an apparent readiness to act should the balance tip towards longer-term inflationary expectations. I suspect they are concerned not only about the economic risks of high and sustained inflation, but also about the Federal Reserve’s own institutional reputation. We can hope that such reputational concerns, along with the hard-learned lessons from the 1970s, will be helpful as they walk the fine line between too much and not enough.
Of course, very little of this month-to-month and even year-to-year noise—be it about inflation, interest rates, or markets—ends up mattering much. Regardless of what’s going on in the world, the big determinants of long-term financial success are the same as they have always been: saving adequately, diversifying prudently, and sticking with a well-thought-out plan. That said, this was an easy quarter in almost every corner of global markets, and the economic backdrop remains strong, secondary to an improving outlook for what looks to be an improving pandemic outlook.
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