Wednesday, July 14, 2021
U.S. and International Equities
This quarter provided positive results for all major market indexes. The top performer and standout was the growth-laden Nasdaq composite, which returned over 9% for the quarter. The international developed and emerging markets, as denoted by the Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East (EAFE) and Emerging Markets (EM) indexes, both finished the quarter higher.
Red hot real estate
After strong performance this quarter, real estate is gaining ground in becoming one of this year’s top performing sectors. The economy’s strong reopening as well as recent interest-rate stability have increased the bullishness among real estate investors.
Value vs. Growth
Despite the economic strength and the expectation that value stocks should prevail, looking at the quarterly returns one might conclude that growth sectors held their own in comparison. LPL Research still believes value stocks may reassert themselves and outperform growth over the rest of the year. Please read our LPL blog post Maintaining Value Overweight despite Growth Rebound for more of our thoughts concerning the outlook for value and growth.
U.S vs. International Stock Valuations
U.S. stock valuations are well above developed international (MSCI EAFE) and emerging markets (MSCI EM) price-to-earnings ratios (PE) trading at nearly 22 times the next 12 month’s consensus S&P 500 earnings estimate (source: FactSet). The present gap between the U.S. and developed international valuations has expanded further recently, with the MSCI EAFE Index now priced at an almost 25% discount to the S&P 500, the largest disparity in 30 years. The story is similar for emerging markets, with the MSCI EM Index trading at over a 30% discount to U.S. stocks, which is the largest discrepancy since the mid-2000s.
Quarterly Fixed Income Results
The benchmark Bloomberg Barclays U.S. Aggregate Index rebounded in Q2 after posting its worst quarter since 1981 for Q1 2021. Long term government bonds as denoted by the Bloomberg Barclays Government Long Index were the standout for Q2 as traders took advantage of the Q1 selloff in fixed income. As of the end of Q2, the Bloomberg Barclays Government Long Index was down over 7% in a thus far tough year for bonds.
International bonds, denoted by the Financial Times Stock Exchange (FTSE) World Government Bond Index, and emerging markets debt, measured by the JP Morgan Emerging Markets Bond Index (EMBI), ended the quarter higher while bond yields lowered as traders took advantage of last quarter’s bond malaise.
Commodities were higher this quarter. Natural gas and oil both enjoyed double digit returns as demand has outstripped supply. Copper, silver, and gold all finished the quarter higher, with both silver and gold rebounding from last quarter. Copper is up over 20% year-to-date.
U.S. Economic Data Recap
Inflation: Consumer prices increased for the third straight month in May. The headline Consumer Price Index (CPI) annual rise was the largest since August 2008. One major reason for the increase was the base-effect due to the depressed economic conditions last year caused by COVID-19. Removing volatile food and energy prices, the May core Consumer Price Index increased over 3.5% from May 2020. This was its largest increase since June 1992.
Producer prices in May increased at its fastest rate on record. Year-over-year, the May PPI increased over 6.5%, while its month-over-month increase was almost 1.0%. May’s inflation showed to be quite substantial; however, we believe any inflationary pressure will mostly prove transitory.
U.S. Consumer: The Conference Board’s Consumer Confidence Index improved in Q1 and surged to its highest reading since the onset of the pandemic. The Present Situations Index also grew, reflecting the continued economic recovery. Both the Consumer Confidence and Present Situations Index held relatively steady in Q2 with both May and April’s readings taken into account.
In March, the University of Michigan consumer sentiment survey increased during Q2. June’s reading increased but less than what economists expected.
Retail Sales: Monthly retail sales were quite volatile last quarter and were quite influenced by government stimulus. This quarter retail sales appear to be tapering. April’s numbers came in unchanged in comparison with March. Automobile and parts sales increased almost 3% where an available car shortage has driven prices higher. In addition, restaurant sales increased 3% month over month.
Retail sales declined more than expected in May; falling over 1% on a month-to-month basis. The decline marked a change in consumer spending from larger purchases, such as home furnishings, to goods and services related to entertainment and travel. Spending at restaurants and bars rose to above pre-pandemic levels. Retail spending in May, however, increased almost 30% on a year to year basis.
U.S. Home Sales: Home sales surged to begin the year and are showing some signs of possibly leveling off. Sales of existing homes in May declined less than 1%. Rising home prices and low inventory are driving potential buyers out of the market. The median existing home price in May was over $350,000, which was up almost 25% from May 2020. Moreover, last month’s home value increase marks over 100 straight months of year-over-year price gains. Over 1.2 million homes were on the market at the end of May, which represents an over 20% year-over year decline.
Small Business Sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index presently sits above its 47-year monthly average of 98 this quarter at 99.6. Over the past couple of months, the NFIB report has expressed concern about a tightening job market. In May, 48% of business owners reported unfillable job openings, which represents an all-time record high. This, most likely, will cause additional upward pressure on wages and compensation. In addition, the NFIB noted inflation as a concern with 43% of respondents stating that they plan to raise prices in the next three months.
Federal Reserve (Fed) News: As most market participants expected the Federal Reserve (Fed), after its June Federal Open Market Committee (FOMC) meeting, made no changes to current monetary policy. However, more Fed members expect two quarter-point interest rate hikes in 2023, which was sooner than many market participants expected.
The recent release of the Federal Open Market Committee (FOMC) meeting minutes showed that the FOMC is split on tapering. Several members advocated tapering purchases of mortgage-backed securities (MBS) given elevated housing prices. Others preferred tapering both Treasuries and MBS at the same time. The next FOMC meeting is at the end of July where we expect more to be discussed on this topic.
U.S. Employment: The U.S. unemployment rate has declined substantially from last year’s peak but with the June unemployment rate at 5.8%, this is still well off full employment levels. Even as we successfully handle the COVID-19 mitigation efforts and reopen the economy, labor market slack needs to improve in order for the economy to reach full-employment.
For quite some time, investors have been focused on COVID-19 cases and their effect on the economic reopening efforts. However, given the most recent inflation data, market participants will be focused more on inflation and its effect on the Fed and interest rates, the economy, and corporate profits. Strong earnings have been an important driver of this year’s strong stock market performance, however, markets are forward-looking. The ability for companies to successfully absorb higher input costs and pass them onto their consumers will play an important role in future earnings results. This month could prove interesting given that 2nd quarter earnings reports will be released very shortly.
The Fed, along with LPL Research, believe that inflation is mostly transitory and will stabilize once the economy completes its reopening and supply chains are fully operational. As noted earlier, labor shortages could be a critical hurdle to overcome. To conclude, the major question that market participants want answered is how long the “transitory” period will last and what impact that may have on Fed policy, interest rates, economic growth, and corporate profits. This theme will most likely influence the rest of this year’s market performance.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
Investing involves risks including possible loss of principal.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. All market and index data comes from FactSet and MarketWatch.
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All index data from FactSet.
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