As I consider the stock markets’ unrelenting rise from the COVID crisis lows of March 2020, I can’t help but think of Alfred E. Newman, the face of Mad magazine, and his slogan “What, me worry?” Despite there being no shortage of worries that could conceivably derail stocks, the large cap S&P 500 has hardly blinked over the past 15 months. This index was up a sizzling 8.6% in the 2nd quarter. Foreign stocks had a great quarter as well, with the MSCI EAFE index of established foreign economy stocks up 5.2% and the MSCI Emerging Markets index up 5.1%. Year to date through June, these three indexes were up 15.3%, 8.8%, and 7.5%, respectively. In the 2nd quarter, bonds as measured by the Bloomberg Barclays U.S. Aggregate index recouped about half of their 1st quarter losses and were down 1.6% through June.
While the S&P 500 has been hitting new highs recently, less concentrated measures of the stock markets’ health have largely been trending sideways for the past three months. This is viewed by many as a “healthy consolidation” as it allows earnings to catch up to elevated prices, thereby improving valuations. The S&P 500 continues to be heavily influenced by the fate of its five largest constituents. The five largest stocks in this index now comprise 21% of the total market value of the index, the highest level in over 40 years according to data from Ned Davis Research. I mentioned in my 1st quarter letter back in January that I felt we were possibly witnessing the beginning of a relative strength rotation into other segments of the stock market. This was in full swing the previous two quarters, but as interest rates have fallen in the 2nd quarter, the technology sector has again come back in favor and resumed leadership.
Which brings me to perhaps the biggest question about the financial markets: What is the bond market telling us? The yield on the 10-year Treasury began rising last summer, and in March of this year, it looked like a foregone conclusion that it would hit 2.0%. Instead, it topped out just shy of 1.8% and has trended lower ever since. It closed today (July 15) at 1.3%. So much for hitting 2.0%. Generally, when yields are falling (and prices rising due to the inverse relationship between prices and yields) it is an indication that bond traders and investors are expecting the economy to slow. It is this belief that led to the outperformance of technology stocks in the 2nd quarter as investors tend to favor higher growth stocks in a slowing economy. While the rate of growth in the economy and earnings versus a year ago will inevitably decline as comparisons move past the economic bottom of last year, growth had been expected to remain strong. Either the bond market is saying a bigger than expected slowdown is coming, or there are other forces at play impacting the bond market.
Inflation has been a hot topic as recent reports have shown a sharp increase versus last year. I normally prefer year-over-year comparisons as this allows for an apples-to-apples comparison versus the same period a year ago, thereby eliminating any seasonal distortions. However, in this case I do not place much weight on these comparisons as last year’s shutdown of the global economy greatly suppressed demand. Instead, we have been analyzing various measures of inflation versus two years ago on an annualized basis. These have been trending higher, though most are not yet at a level that would seem to be troublesome. Some of the inflation readings on a sequential basis (versus the previous month) have been very high and likely would be problematic should they continue.
As always, we are monitoring market conditions and making adjustments in portfolios as we deem appropriate. Please let me know if you have any questions or anything we might be able to help you with.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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