When I think about any good happy ending in a movie, the hero gets the boy (or girl) or saves the earth from mass destruction. When it comes to happy endings in investing, we would all like a stock market that goes up nice and smoothly without the boogeyman of volatility. And guess what? That is what we just experienced this last quarter.
The stock market hasn’t been this placid in years. Consider the fact that the equity markets have not had a significant sell-off of 5% or more since October 2020, which is a pretty long stretch of sustained and steady growth. Especially when you are looking at the overall picture of where we were back then, and where we are today.
Markets are incredible at taking in information and absorbing it, while simultaneously acting like they are ignoring that same information and news. It is very similar to a rip tide in the ocean. On the surface, the water looks fine and inviting and smooth, yet underneath the surface, there can be an invisible rip-tide forceful enough to yank you out to sea.
Every Good Story Has a Villain
When it comes to wealth, there are major distractions for anyone approaching the sunset of their career. It’s critical to address the wild cards of taxes, volatility, and timing to protect the wealth you’ve worked so hard to earn. The solution is simple: invest for the long term. But we should also address the villains in the near term and how we think of them.
Under the surface of looking at market averages, there have been swings between sectors, market caps, and plain old style and preference. Growth vs. value plays. Stay-at-home vs. reopening themes. One day value beats growth, but the next day the exact opposite happens — sometimes with no logical or obvious explanation.
This action is normal in times when markets are recalibrating asset allocation levels and to me, this all feels very macro-driven by interest rates, liquidity, and the economy.
Enemy #1: Interest rates
Last quarter everyone was freaking out like the world was coming to an end because 10-year Treasury spiked all the way to 1.75% on inflation fears. Now we all have accepted what The Fed has been saying for a while now, which is that inflation is transitory and the 10-year Treasury is now back down to 1.25% as of this AM - July 8th!
The Fed continues to be a hot topic in the media. Last month’s Fed scare showed just how sensitive stock markets are to Fed speak with the talk of rate increases coming in two years instead of three as previously anticipated. That created pressure on stocks and the S&P 500 fell more than 2% in three days before resuming its upward climb and hitting all-time highs.
Mega-cap stocks almost instantly react to movements in interest rates. Value names in certain industries are being actively accumulated as they sell off to levels where buyers feel the price is right. Indexes as well are being bought at levels of support, as “buying the dip” has not gone out of style yet.
Enemy #2: Liquidity
All that smooth surface water that looks so inviting has lured a lot of money into the market. Those investors are driven by FOMO (Fear Of Missing Out) and TINA (There Is No Alternative). That means they’re chasing gains in the stock market because Treasuries, corporate bonds and cash are offering paltry returns right now so stocks are their best hopes for beefier gains.
Hero #1: The economy
Now that we’ve talked about the villains, let’s look at our hero. The economy is really strong! Businesses are getting back to normal, backbone industries like tourism and restaurants have reopened, employment rates are strong, vaccine rates are up and covid cases are down. People are getting back to work and we are starting to get back to normal. It feels good, and people are happy and optimistic. Everyone’s portfolios are doing well thanks to those sustained runups in the stock market.
People are still a little worried about inflation, but the mad rush to do home improvement projects during the pandemic is slowing down and that should put a damper on inflation too.
So where are we?
It’s time to start planning for a little wobble in the economy, the stock market or your personal financial position. Some employers are demanding we head back to at least some face-to-face work and we are all adjusting to new hybrid work situations, uncertainty about whether corporate travel and in-person conventions will resume, and questions about hiring, pay raises, bonuses and other compensation.
We might be at peak-ish growth. We seem to be past the worst of inflation. And we are probably at peak-ish liquidity.
Taken together, that means we all have to prepare for an uptick in volatility, and a slowdown in our economy after the summer months that will probably be offset by less inflation.
Our big-picture views going into the back half of the year are:
We are optimistic about corporate earnings growth which should outweigh the possibility of higher corporate taxes.
We’re getting a little defensive with healthcare ETFs, which is very attractive right now and has good growth fundamentals.
We are still bullish on metals, mining and materials. Physical demand is strong and inventories are generally being drawn. Commodities are still the best-performing asset class YTD, despite a pullback in Q2 (except for oil). Gold and Copper have sold off sharply, with the latter suffering further from a positioning unwind due to Chinese government intervention. But we remain structurally bullish on Copper thanks to green demand and chronic underinvestment in the supply side.
We continue to prefer non-US to US equities due to a desynchronized COVID-19 recovery and value exposure, but also headwinds for US earnings from taxes next year. We see further cyclical upside in emerging markets equity.
But we still continue to invest in the S&P 500 and other benchmarks with some slight tilts like high tech growth with NASDAQ, clean energy storage with Lithium, reopening trade with JETS, and small and medium caps ETFs.
Please call me if you have any questions about our thinking going into the second half of the year, or if you would like to just catch up. You can check out your portfolio’s performance at FolioClient.com.
Thank you again for working with us as we build and protect your wealth.
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