Market Review & Outlook

Performance Review

Following a positive (albeit volatile) first quarter, stock indices continued to rise, with the S&P 500 (US Equities) and ACWI ex USA (International Equities) finishing the quarter up 8.53% and 6.31%, respectively. This brings their respective year-to-date performances up to 15.23% and 10.02%, reflecting an economy that is opening back up following last year’s COVID-19 pandemic. The US Bond market, represented by the Bloomberg Barclays US Aggregate Index, has not fared as well, having returned -1.74% so far this year amid rising yields.

A Shift in Sentiment

One of the main stories of 2021 so far is an apparent changing market sentiment towards both Value/Growth stocks, as well as Small/Large stocks. Looking at the trailing five-year period, the story has been clear: Growth stocks have outperformed Value, and Large stocks have outperformed Small.

Using the Russell 3000 Growth and Value indices as proxies for Growth & Value stocks, it is clear that Growth has outperformed Value by a significant margin over the past few years.

At any point over this time-period, one could find various articles and opinion predicting any possible combination of outperformance. Just look at the variety of Value vs. Growth takes from 2019! Value will outperform Growth, but not for years to come (and it may not last). In case the suspense is killing you… somehow all of these takes were wrong. Growth continued to outpace Value through 2020, and has so far lagged through 2021 (so much for “years to come”):

Despite the bold predictions linked above, the trend continued throughout 2020 with Growth again outperforming Value by a large margin.

However, so far in 2021, the US markets have notably shifted back towards the previously out-of-favor segments. Large companies have lagged, and so have Growth stocks.

So far in 2021, the trends for both Growth/Value (Left) & Small/Large (Right) stocks have reversed, though it remains to be seen if this trend will continue into the future.

All of this is to say: it is incredibly difficult to accurately predict and time rotations into/out of various market segments. There is no saying whether this trend will last, or if it will shift back towards the longer-term trend, but this is just a small example of why we, as advisors, constantly preach diversification.

Economic Landscape

Over the past sixteen months, along with causing tragedies in countless families across the world, the COVID-19 pandemic has caused a significant slowdown of the US economy. While looking at basically any economic measurement from early 2020 is likely to cause your eyes to widen, GDP shrinking by nearly one-third in the second quarter last year is likely the number that sticks out most in my mind. Plotting the previous ten years of data does a good job of illustrating the severe fluctuations the economy has gone through:

The US GDP whipsawed back and forth in 2020 following the outbreak of the COVID-19 pandemic

With the recent widespread deployment of the vaccine across the US, much of the country is now reopening to full capacity, and it appears the economy is headed forward following much of the same trend as before the pandemic.

Employment Scenario

While the economy has begun to correct for last year’s downturn, it has also led to some interesting adverse effects. The past two employment reports have disappointed analysts, coming in short of expectations. Some have cited enhanced federal unemployment benefits as a disincentive for those currently out of the workforce from entering back in, while others point to the challenges faced by parents dealing with childcare as the main cause. While these debates can tend to move into the political realm, regardless of the main culprit, we should begin to see some positive developments heading into late summer and early fall, as enhanced unemployment benefits begin to phase out across various states and more parents begin to drop their children back off for in-person schooling.  

Inflation

Even more so than the employment picture, the inflation landscape has been arguably the most widely discussed economic reading; with inflation increasing faster than expected in March, April, and May, the reason for this is no surprise. However, the debate has shifted recently to whether or not the inflation we are experiencing is “transitory” or not (i.e. will it continue into the foreseeable future or subside as the economy moves back to pre-pandemic normal?). With the Fed on “team transitory”, the market has been able to shake off its recent fears, but this is an interesting point worth investigating. Looking at CPI growth, alongside CPI of Services, Durable Goods (goods that last for at least three years), and Non-Durable Goods (goods that are consumed in the short-term), it becomes apparent where the inflationary pressures are concentrated:

Inflation in Durable Goods is outpacing both Non-Durable Goods and Services, and pulling overall CPI upwards significantly.

Durable goods are pulling the broad CPI measure up higher than both Non-Durable Goods and Services. It seems the takeaway here is that larger purchases – appliances, used cars (up nearly 30% over the trailing 12 months!), etc. – are the main drivers of broader inflation, while Services and Non-Durable goods – Food, House Supplies, Clothing, categories felt by nearly every participant in the economy – have seen more modest increases. Looking through this lens, it is easy to see why the Fed has wound up on “team transitory.”

Looking Forward

The third quarter of 2021 should provide answers (or at least some more clarity) on many of the big questions mentioned above, mainly:

1. 1. Will the economy continue to grow on pace with its previous trend?
   2. Will the employment picture become rosier, or will the supply of labor continue to lag the white-hot demand?
   3. Will we continue to see accelerating inflation, or will it turn out to be transitory, after all?

I look forward to watching these answers come into focus over the coming quarter, as well as sharing the results with you in my next writing.

As always, feel free to reach out to myself or the rest of the team if you would like to explore any of this further.