Investment Optimism Still on the Rise
Posted on June 30, 2021
The second quarter of 2021 essentially continued the modest progress we experienced through the first quarter of the year across global equity markets. While much of the market exuberance has dissipated, investors remain willing to invest as markets grind to higher levels. To be clear, there is still good reason to be optimistic. Global economies are rebounding quickly as COVID-19 vaccination levels increase around the world, particularly across developed nations. Coupled with improving labor markets, rising prices, and exceedingly accommodative monetary and fiscal policies, we should expect robust economic growth through the remainder of this year and well into 2022.
However, we also understand capital markets are forward looking and much of the aforementioned good news is being priced into stocks and bonds today. For that reason, we are being ever vigilant in our valuation work to safeguard against systematically overpaying for the stocks and bonds we purchase on clients’ behalf. Given the expectation for strong growth across global economies, investors have become increasingly wary of inflation concerns, particularly in the context of the Federal Reserve Board’s exceedingly accommodative monetary policy stance. On June 16, the Fed’s Open Market Committee (FOMC) met and revised its forward assumptions. The FOMC addressed the inflation landscape, which is key to understanding when and how the Fed plans on tightening its policies as we work our way out of the 2020 recession. While the FOMC did indeed revise higher its own inflation expectations for the year, members remained willing to allow inflation to run ahead of their long-term target of 2% to ensure the economy and labor markets continue to heal. While we still expect no change in the Fed Funds rate before 2023, we do anticipate the Fed will address their bond purchase program sooner than was expected just a few months ago. Changes in Fed policy often cause additional short-term volatility across capital markets; however, let’s also recognize that normalizing our monetary policy is a healthy and necessary step towards achieving longer-term economic stability.
Fed decisions certainly impact equity markets, but they also carry significant sway over fixed-income (bond) markets. Given historically low bond yields and the expectation of rising rates on the back of inflation, we would rather keep our bond exposure primarily to short term maturities. Given the inverse relationship between interest rates and bond prices, we want to limit our risk when buying and holding bonds for clients. Subsequent to interest rates rising, we will be ready and willing to extend our duration across our bond holdings for those clients where bonds are appropriate.
Throughout prior articles, we have highlighted the differences between growth and value stocks over the past several years. Last year, as the pandemic took hold, growth stocks’ outperformance continued as interest rates were lowered and free money was made available to businesses and consumers. We saw a sharp reversal in this dynamic during the first quarter of 2021 as inflation expectations increased. Interestingly, growth stocks are beginning to perform relatively better again despite expectations that interest rates will move higher. We continue to believe that value and dividend-paying companies offer slightly better forward return prospects than many of their growth counterparts – due to the valuation disparity that exists between these types of companies. However, we certainly recognize the futility in timing such shifts in market sentiment, which is why we will continue to advocate for a well-balanced diversified portfolio for our clients.
Ian N. Breusch, CFA
Chief Investment Officer