The US economy is growing faster than expected as state governments largely dropped Coronavirus restrictions across the country during the 2nd quarter of 2021. The Federal Reserve Bank of Philadelphia projected real GDP growth to be 2.9% back in December for the first half of 2021. They’ve since revised their projection to expect real GDP growth to come in around 7.8%. Their projection for the rest of the year is real GDP growth to now be at 6.7%, up from an earlier projection of 3.7%. What this means is that the economy is moving along at more rapid pace compared to expectations. To put this in perspective, real GDP growth has not been higher than 3% on a yearly basis since 2005 and not higher than 5% since 1984 (source: macrotrends.net). While life in the U.S. has largely normalized, many foreign countries still have high infection rates with many restrictions still in place.
U.S Stock Market
Large Cap U.S. stocks, as measured by the S&P 500 Index, rose 8.5% for the quarter. Mid and Small Cap company stocks underperformed the S&P returning 3.6% and 4.3% for the quarter as measured by the S&P Mid Cap 400 and Russell 2000 Index. The NASDAQ Composite Index led posting a 9.7% return as interest rates dropped throughout the quarter boosting these generally growth-oriented stocks. Still this index trails the S&P 500’s return year-to-date suggesting that this was a bit of a catchup for this sector of the market.
International Stock Markets
U.S. stocks are up around 15% for the year, and international stocks are once again underperforming with the EAFE index returning 8.8% year-to-date. Some firms, such as Vanguard, recommend as much as 40% of your stock allocation in international stocks. At CRA we generally construct portfolios with a much smaller allocation to these stocks. The logic behind our thinking is that companies in the S&P 500 often receive half if not more of their revenue from overseas as they are giant multinational corporations. Secondly, there are always additional risks associated with investing overseas. This is because investors are subject to currency risk as well as different political risks from many different governments when they invest internationally. Lastly, we feel the U.S. generally has better innovation compared to most other countries. As an example, the largest component of the S&P 500 is Apple. The largest component in the EAFE international index is Nestle. While it’s impossible to predict the future, we’d rather our clients own more companies like Apple than Nestle as we feel their return potential is greater.
Emerging market stocks returned just north of 5% for the quarter. Another wave of Coronavirus peaked in the 2nd quarter in emerging markets such as India who experienced their worst outbreak since the pandemic began. Many of the companies in these markets will remain challenged as it could take months if not years to fully vaccinate the world. Still, emerging market stocks could see a boost over time as things gradually return to normal worldwide.
A key theme that remains for 2021 is watching interest rates closely. These rates greatly affect both stocks and bonds. Interest rates rising in February and March caused volatility in the markets. This was seen particularly in the riskier more speculative stocks. Interest rates have since declined and these stocks have in many cases recovered. As the global economy recovers, it’s possible these rates tick up over time which would once again put pressure on the more speculative growth stocks. For this reason, we feel maintaining a disciplined approach to investing and a balanced portfolio is crucial to avoiding excess risk.
The 10-year Treasury yield moved downward throughout the quarter from 1.74% to 1.44%. These lower rates make borrowing across the economic system cheaper which can help the economy expand. Additionally, keep in mind that when interest rates fall, bond prices rise. Consequently, the U.S. Aggregate Bond Index rose 1.83% for the quarter. The 30-year Treasury bond ended the quarter with a yield of 2.06%.
The Fed continues to leave their key Federal Funds rate at 0%. Furthermore, they have said that they expect to leave interest rates at 0 through 2022 with two expected interest rate hikes to come in the end of 2023. This is actually sooner than they anticipated back in March when they said they expected rates to hold steady throughout 2023 as well. St. Louis Fed President James Bullard spooked the markets on Friday, June 18th when he said that he sees 2022 as a possible timeframe for when a rate hike could occur. The equity market quickly shrugged off these comments the following trading session and continued moving generally higher since. While the market quickly recovered from his comments, it is clear that any sign of rate hikes could have a dramatic impact on stock markets. For this reason, our team continuously tracks interest rate movements and the Fed’s commentary. Additional Fed tightening is also expected although the central bank has yet to give an indication as to when it will begin cutting back on its aggressive bond-buying program.
Oil Prices and Energy Stocks
Oil prices surged around 24% for the 2nd quarter of 2021 with the price per barrel closing at $73.47 on June 30th. Energy stocks saw a boost with these higher prices and once again this sector was the top performing sector for the 2nd quarter of 2021 seeing a 12.2% return.
Most economists feel that we are in the early to mid-part of this next economic cycle. It’s important to not lose sight of this and remain disciplined when volatility inevitably creeps into the market. While holding stocks can, at times, be a bumpy ride, they have historically been a great hedge against inflation. Additionally, with low rates on fixed income securities, most clients may continue to allocate a healthy portion of their portfolio to equities in order to achieve the necessary return to meet their goals. At CRA we thank you for your trust in our firm and are grateful to you for helping us grow to $1 billion dollars in assets managed.
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
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