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July 2021 Investment Commentary

The second quarter showed generally healthy returns, driven by further advances in stocks, building on very strong gains since the early days of the pandemic, and some recovery in bonds, from sharp earlier-year declines.  The reopening effect has proven to be powerful thus far, supporting economic and corporate performance and recoupment that have beaten most expectations.   Policymakers commanded extra investor attention as has been true since the initial COVID-19 response, updated for events.  Firming inflation readings have prompted a moderately altered stance at the Federal Reserve, and government spending plans, on infrastructure and other priorities, now are subject to the normal political tug of war, the emergency carte blanche having effectively expired.

  Second Quarter Year to Date  Five Years (ann.)
World Stocks 7.4% 12.3% 14.6%
S&P 500 8.6 15.3 17.7
Emerging Markets 5.1 7.5 13.0
Developed International Stocks 5.2 8.8 10.3
World Bonds 1.3 -3.2 2.3

The recovery in bonds, with the 10-year Treasury rate easing back from 175 to 147 basis points, half the move happening in the quarter’s last two weeks, was perhaps an appreciative nod to the Fed’s Jerome Powell and his committee.  The June meeting marked a new recognition of above-expected inflation (still regarded as transitory and tied to reopening logistics) and a walk-back of an earlier assertion, unique in its length, of no policy rate increases through 2023.  The hotter inflation numbers indeed have arrived: the central bank’s bellwether Personal Consumption Expenditure index’s year-to-year increase in May was 3.4%, the largest since the 1990s and well above the Fed’s traditional 2.0% upper band.  This prompted a shift in the committee’s “dot plot” policy rate forecasting grid, suggesting the first rate increases as early as late 2022.   A tapering of the Fed’s Treasury and mortgage-backed bond purchases also has been moved forward.  Investors seemed to take solace that policymakers were on top of the issue.    

The Fed shift also is an indication of improved economic conditions, and vaccine-assisted recovery from COVID.  According to Oxford University, the U.S. is now 46% fully vaccinated, second only to the U.K.’s 49% among major economies.  Continental Europe is mostly in the 30s, and Japan is at 12%.  Much of the world has had at least one shot, with just over 3 billion doses administered, or 40 per 100 people. Daily cases in the U.S. are now around 12,500, the lowest since testing became available, compared to peak amounts above 250,000 early this year.  Notwithstanding lingering viral threats including the Delta variant, which was first seen in India and now accounts for one out of every five infections here, most states lifted their masking and other restrictions in late May or June.  The reopening effectively has begun.

Not surprisingly, given the power of a national restoration of economic activity, the near-term outlook is very good.  On the heels of 6.4% GDP growth in the first quarter, projections are closer to 8% for the second quarter, leading to a full year expansion around 7%.  While recovery earlier in the year owed much to a rebound in durable goods orders and manufacturing, the consumer is poised to take the lead at the mid-year mark. Sentiment indicators are at high levels, and households are in a strong position with upwards of $3 trillion in savings.  This suggests a powerful combination with the more recent reopening of consumer service sectors, pointing to pent-up spending for travel, events, restaurants --- and countless other forms of entertainment that take place away from the home.

Labor markets continue their recovery, during what is still a transitional period.  In the 14 months since April 2020’s seismic 20.7 million job loss, 15.6 million jobs have been regained, including a healthy 850,000 just added in June.  Further, job openings now exceed 9 million.  This suggests that several million of today’s working age people simply are not actively looking for employment.  Part of this might reflect a location mismatch, caused by a flight from cities triggered by the pandemic.  Continuing fear of COVID also is in the mix, according to a recent poll.  And federal enhanced unemployment benefits, phasing out by September, arguably disincentivized a return to work over much of the COVID period, while also contributing to an atrophying of skills.  More broadly, work lifestyle is under review as workers return, not wanting to leave completely behind working from home and seeing more of their children.

As roughly $6 trillion in emergency federal spending since March 2020 runs its course, President Joe Biden continues to favor aggressive fiscal support.  He has made progress on an ambitious infrastructure plan, announcing in late June a deal reached with a bipartisan Senate subgroup, in which $973 billion would be spent over five years, focusing on roads, bridges, transit, and the electrical grid.  Biden’s team brought in Republicans by omitting corporate tax increases as a funding source.  Financing instead would come from repurposing existing federal funds, enhanced tax compliance, and government sales from the strategic petroleum reserve and wireless-spectrum auctions.  While scaled back from earlier versions, the Biden program still would be the largest investment since FDR.  A topic that normally appeals to both parties, comprehensive infrastructure legislation proved to be elusive under President Donald Trump, and also President Barack Obama, other than recovery spending enacted in his first year.  Many steps lie ahead, with initial votes possible later this month.

After a year in which U.S GDP growth might compete with the 50 year high of 7.2% in 1984, a cooldown is very likely in 2022, with estimates currently around 4%.  This pattern may hold globally as well; the Organization for Economic Cooperation and Development (OECD) now projects 5.8% GDP growth this year, followed by 4.4% growth in 2022.  But, viewed in the context of recouping lost output, there still is room to run.  Among the G20 countries, nine are expected to recover to pre-COVID GDP levels by the end of this year, including the U.S., China, Korea, Japan, and Germany.  The OECD calls for most other major economies to reach this milestone sometime in 2022, with Spain and Mexico among the five post-2022 laggards.  All told, global output by end-2022 is expected to be roughly $3 trillion less (at about $94 trillion) than had been expected before the pandemic struck.

In the effort to reclaim lost output and boost productivity, the post-COVID redefinition of work may have more positive and durable impacts.  Marc Andreesen, a tech entrepreneur, venture capitalist and well-regarded visionary, expressed in a recent blog post that the normalization of working from home represents no less than a “permanent civilizational shift”, on par with the creation of the internet itself, that will allow for much better application of human capital.  Talented people will be able to access good jobs as easily from rural areas and small towns as from expensive cities, leading to major job expansion and “dramatically improving quality of life for millions, or billions, of people”. While some would challenge this view, pointing to mass vaccination and a human need for interaction as pro-urban, we have already seen a migration of knowledge workers from the most expensive cities to so-called “secondary” cities, such as Denver, Austin, and Nashville.

Moving into the back half of 2021, valuations of both stocks and bonds are on the high side.  Arguably, stocks are well supported by recently robust corporate performance.  First quarter earnings growth of better than 45% year-to-year now is giving way to a second quarter forecast closer to 60%.  Comparisons over the year’s second half, measured against recovering financials of later 2020, will get a bit tougher, while still hovering around 20%.  In aggregate, next-twelve-month price-earnings ratios are just over 20 times, within shouting distance of long-term averages in the upper teens.  Bonds, having rallied in recent weeks, appear to be pricing in cooler economic growth as well as shrugging off any real concern about inflation.  Supply chain de-bottlenecking has already become evident in raw materials such as lumber, whose prices have dropped following an earlier surge.

We continue to favor a full allocation to stocks, but always counsel sticking to the discipline and rebalancing portfolios.  We reinforced this point in April 2020 following major equity weakness, indicating a need to restore exposure, and now reaffirm the merits of trimming back as needed on strength.  Following previous adjustments of holdings over the last two quarters, we feel the equity book is well balanced between growth and big tech, and cheaper value, more cyclical names.  Inclusion of non-U.S. stocks continues to be favored as a diversifier and also on valuation grounds: the developed international and emerging market groups trade at respective price-to-book discounts of 58% and 52% to the S&P 500.

The bond (plus cash) allocation continues to provide portfolio defense.  Core exposure is downplayed and diversification across flexible mandates is favored.  Protection in the event of new surprises on the inflation front, or any type of taper tantrum as the Fed taps the brakes on bond buying, is kept in place. 

We hope the summer is treating you well so far.  As always, please feel free to contact us with questions or comments.


David S. Beckwith, CFA

Managing Director & Chief Investment Officer


This letter may include forward-looking statements.  All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”).  Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct.  Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.