If investors were hoping for a nice, calm year after all they experienced in 2020, their hopes were dashed. So far this year, we have seen interest rates rise sharply, inflation jump to levels not seen in decades, and expected GDP growth higher than any time since the end of World War II.
The so-called “meme” stock trade introduced volatility and drama. Retail investors exerted their buying power, fortified by stimulus checks, to push select stocks to astronomical prices. The lucky investors cashed out before prices came tumbling down, wiping out many other investors’ accounts.
The popularity of cryptocurrencies increased as speculators took to social media to hype their coins. At one point, more than $1 trillion in market capitalization was wiped out as prices on a variety of coins plunged. Bitcoin, the largest coin by market cap, slipped below $35,000 in May after having traded close to $65,000 a month earlier.
Equity markets experienced several significant pullbacks of 5% or more in these first few months of the year, and yet at the end of May we are nearing the all-time highs the S&P 500 reached at the beginning of the month. Through May 31, US small cap stocks (Russell 2000) returned 15.30%, outpacing US large caps (S&P 500) and foreign stocks (MSCI EAFE), which returned 12.62% and 10.07%, respectively.
Although interest rates have declined from their highs in March, fixed- income securities struggled, with the Bloomberg Barclays US Aggregate Bond Index returning a negative 2.29%, year-to-date.
In equity markets, the cyclical value sectors continued to outperform as strong economic growth prospects lifted investor sentiment. The energy, financials, and industrials sectors have experienced the strongest returns as economies around the globe reopen.
In fixed-income markets, high-yield bonds continued to outperform more interest-rate sensitive areas of the market. These latter sectors tumbled even as the 10-year US Treasury reached 1.77% on surging interest rates during the first five months of the year. High-yield and floating-rate loans, both less interest rate sensitive, outperformed on a relative basis. As rates have declined from the March highs, the outperformance gap has narrowed.
Inflation has become a growing concern for fixed-income and equity investors. The Consumer Price Index, or CPI, increased at a slightly above-average annualized rate of 2.6% in March. Readings for the next two months caused investors concern on increased volatility, as inflation was reported in April at 4.2% and May at 5.0%.
Many economists feel the inflationary surge is transitory. Undoubtedly, base effects and supply shortages continue to put upward pressure on prices, but an accompanying persistent climb in wages would need to be seen in order to trigger concerns over a potential long-term trend. So far, that has not been confirmed by several of the employment cost index or business surveys.
According to Ned Davis Research, global GDP growth is expected to reach 6.1% this year. The service sector is expected to lead growth in the second half of 2021 as vaccine rollouts and reopenings continue across the globe.
These higher-than-normal growth rates are not likely to last forever. Consumer spending is expected to decline once stimulus checks are spent. However, capital spending may remain quite strong and should help ease fears of higher, sustained inflation in the long term as companies maintain the ability to provide jobs and remain productive.
Employment data continues to improve. The unemployment rate declined to 5.8% at the end of May. As of this writing, there are 8.1 million job openings, and more are expected as small businesses foresee increased hiring through the end of the year. More than 559,000 jobs were created during May, nearly double the lackluster 266,000 total from April. This bump helped reassure investors. Initial jobless claims have continued to decline on a weekly basis.
Central banks around the globe have remained accommodative. Both the Federal Reserve and the European Central Bank, or ECB, maintained their low rates and pace of asset purchases. The minutes from the April Federal Open Market Committee meeting showed that several members want to begin discussions on curtailing bond purchases at future meetings. Fed officials reiterated that they would communicate any changes well in advance.
As long-term investors, the constant ebb and flow of the market is a reminder of the importance of diversification and appropriate asset allocation.
If you have questions, as always, contact your Regency Advisor.