AAF Wealth Management Q2 Market Update
Summer is here, just in time for us to emerge cautious and bleary-eyed from quarantine. It’s been more gratifying this summer, in particular, to reunite with family and friends, connect in person with colleagues, and recharge with much needed vacations!
The global economy and financial markets are gaining momentum as people get out and spend after a prolonged dormant period.
In the following quarterly update, AAF Wealth Management reviews how the markets fared in 2021, provides an update on the current business cycle, shares expectations, and provides thoughts on Wall Street’s favorite topic of debate: inflation.
“The More Things Change, the More They Stay the Same.”
Attributed to the 19th century French writer Jean-Baptiste Alphonse Karr, the aforementioned axiom is often used to describe periods of change where, at the surface, there appear to be significant variations from the past, but in reality, life continues in much the same way it always has.
As we entered 2021, our collective focus was on what a “reopening” of society would look like. Given the improving economic backdrop and low interest rates, there was little reason to believe life wouldn’t return, at least in some semblance, to that which we had remembered prior to the start of the pandemic.
States have mostly reopened with few restrictions in place, workers are returning to their offices, and economic data is positive. Yet, at the same time, the common bugaboos that historically challenged periods of economic expansion are starting to crop up once again in the daily conversations of investors, including talk of inflation, higher interest rates, bubbles, and speculative manias.
Did Peter Benchley have the 2021 financial markets in mind when he wrote Jaws in 1974, and the famous line, “is it safe to go back in the water?” It seems especially apropos of the current financial landscape.
Market Commentary: First Half of 2021
To recap, here are but a few of the events that made headlines from January to June:
- The rise of vigilantism by Reddit’s “Wall Street Bets” investors as they took on the Wall Street “establishment,” attempting to force short squeezes on meme stocks such as GameStop and AMC
- A 100% increase in the US 10 Year Treasury interest rate between January and March…
- ….and the subsequent 30+% decrease in the same 10 year note since April 1st!
- The loss of value (in some cases) of 90% or more of the 2020 bull market darlings: “SPAC” stocks
- A leverage related implosion of the $20 billion hedge fund Archegos, reminiscent of the late 1990s
- The parabolic rise and fall of Bitcoin, Ethereum, and myriad other crypto currencies
And through it all, the markets endured!
As of June 30th, the S&P 500 was positive with a 15.25% return; the Dow Jones delivered a 13.75% increase; international developed countries (covered by the MSCI EAFE Index) were positive 8.83%; and Emerging Markets returned 7.45%. Only the Barclays Aggregate Bond Index came up short, with a slightly negative return of (1.67%). In light of the enormous volatility in interest rates already addressed, a loss of less than 2% in bonds is nothing short of a miracle.
The Business Cycle and Market Expectations
By definition, a Business Cycle is a 1-10 year cycle defined as having four distinct phases from start to finish: Early, Mid, Late and Recession. During each of these four phases, different styles of stocks (growth vs. value), market caps (small, medium, large) and sectors (Tech, Financials, Real Estate, etc.) rotate among one another given the current phase. Fiscal and monetary policy, interest rates, and credit availability also play large roles in each of the phases.
Based upon the types of sectors that have shown leadership in 2021 (i.e. Industrials, Financials, and Energy), and factoring in the Federal Reserve’s current accommodative, but likely “shifting to a neutral” view on economic policy, it’s reasonable to believe that we’re transitioning from the “late-Early” to beginning of the “Mid” Phase of the business cycle. Historically, the Mid Phase has the longest duration (on average 3-5 years), witnesses the most changes of leadership among types of stocks, and encounters various periods of volatility. Perhaps more than any other period in the business cycle, the Mid phase serves to underscore why we preach the tenants of diversification, taking a long term approach to investing, and not attempting to time the market.
Potential Risks and Considerations
We remain optimistic, but never lose sight of potential risks and considerations.
Chief among our concerns is the notion of inflation and whether or not the various economic data that pertain to inflationary measures recorded in Q2, 2021, is in fact indicative of a transitory inflationary environment (as the Federal Reserve believes)—or something more persistent.
An overheated economy will eventually stall out as consumers lose the ability and willingness to continually pay higher prices for goods and services. A subsequent slow-down in business activity translates into reduced earnings, which in turn leads to a recession (the 4th phase of the business cycle).
Measures of inflation recorded in the 2nd quarter, 2021 indicated very strong readings; however, we remind clients to view these readings with a year over year application in mind. The draw down of economic activity starting in Q2, 2020, was the most sudden drop in American GDP since the Great Depression. And, there was an equally sudden “ramp up” of economic activity in Q1, 2021—springing from the pent up demand of consumers looking to leave their state of lockdown and start living again. That said, it would be foolish to simply dismiss the idea of persistent inflation given the shear amount of governmental stimulus that arose in response to the Covid-19 pandemic. While almost impossible to imagine, collectively the world’s central banks combined for more than 20 Trillion dollars in various stimulus packages and programs since March of 2020.
Finally, and likely the biggest concern is the potential for more dangerous variants of the coronavirus. Should we find ourselves in a position where world economies shut down once again, the markets would surely react negatively.
Despite the risks and volatility that may arise in the current phase of the Business Cycle, we expect to continue to see favorable returns for investors who maintain well balanced, diversified portfolios. Clients of AAF Wealth Management have heard us preach the benefits of “Balance” and “Diversification” as primary tools we use to control portfolio risk and exposure into the different types of assets.
AAF Wealth Management discourages clients from chasing short term stock gains as they can be counterproductive to long-term goals. We recommend a disciplined approach to investing to weather all market cycles.
If you have any questions please contact: Andrew Hammond, CFP® at 774.512.4143, firstname.lastname@example.org; Kevin Hodson, AIF® at 774.512.4173, email@example.com; or your AAF Wealth Management Wealth Advisor.