By Andrew J. Willms
President and CEO
An unexpected decline in Treasury yields led to a positive month for the stock market, with three of the four major stock indexes registering gains in June. But investors had to tolerate a good deal of volatility to book those gains. The Wall Street Journal reports that stocks logged both their worst week since October and their best week since February during the month.
The end of June marked the end of the second quarter of 2021. Both the S&P 500 and the Dow have put together five consecutive quarters of positive returns, the longest such stretch since 2017, with the S&P enjoying nearly a 20% gain for the first half of the year. According to a study by LPL, of the 17 times the S&P rose more than 12.5% in the first half of the year, it rose the rest of the year 75% of the time, with a median gain of just under 10%.
More importantly, data on GDP growth, job openings, consumer spending and business owner confidence all suggest the equities rally should continue. That’s not to say that there aren’t reasons for concern, however.
As Mike Willms (The Milwaukee’s Director of Trading and Market Research) explains in his article for this month’s newsletter, inflation threatens the current bull market. The Consumer Price Index was up 5% year-over-year in May, its biggest yearly jump since 2008 and more than twice the 2% average targeted by the Federal Reserve.
The Fed believes that inflation will recede quickly, and for now Mr. Market is in agreement. But others worry that members of the Fed’s Board of Governors may have their heads in the sand when it comes to the inflation threat.
Count Mohamed El-Erian, chief economic advisor at Allianz, as one of the skeptics. In a recent CNBC interview he said: “Every day I see evidence of inflation not being transitory, and I have concern that the Fed is falling behind and that it may have to play catch-up, and history makes you very uncomfortable if you end up in a world in which the Fed has to play catch-up.”
It’d be hard to convince anyone shopping for a new home that inflation isn’t a problem. According to the S&P/Case-Shiller National Home Price index released last week, housing prices have risen by 14.6% over the last 12 months. This amounts to the highest annual growth rate on record, surpassing even the price surge during 2005-06 housing bubble.
Another cause for concern in some quarters are the high prices being paid for stocks, which has created a long way for equities to fall. Apparently, Goldman Sachs does not share that concern, based on a research note the firm published last week: “We find that unusually low bond yields, low inflation and a rapidly improving labor market are conditions that should be associated with unusually high valuations.”
In this regard, stock market bulls may be right. Some 87% of the S&P companies that announced first-quarter earnings have exceeded analyst estimates, as compared to the long-term average of 65%. Should this trend continue, valuations would be more in line with their historical norms.
Speaking of trends, it is often said that the trend is your friend on Wall Street. And there is no debating that year to date the trend for the stock market has been definitely higher.
DJI - Dow Jones Industrial Average; GSPC - S&P 500 Index; IXIC - Nasdaq-100 Index; RUT – iShares Russell 2000 Index.
Whether interest rates will rise (and bond prices will correspondingly fall) is a debate that is every bit as heated as the one over inflation. Bond prices have struggled for much of the first half of the year, as investors worried that the Federal Reserve could be forced to raise rates faster than it would like to keep the economy from over-heating.
More recently we’ve seen the yield curve flatten. Yields on shorter-dated bonds have risen a bit on suspicions that the Fed will start to raise the Federal funds rate sooner than previously expected. At the same time, longer-term Treasury bond yields have dropped because higher interest rates in the near term could lead to slower growth, which in turn lead to lower rates down the road.
BND – Vanguard total bond market ETF; VGLT – Vanguard 7-10 year Treasury ETF; BNDX – Vanguard Total.
It’s also important not to lose sight of the impact Covid-19 could have on global markets. The transmissibility of the Delta variant is triggering economic shutdowns in some parts of the world, particularly in Asia. If the situation worsens, it could trigger ripple effects that could find their way to America’s shores.
In the midst of all this uncertainty, there’s one sure thing: It’s a very interesting time to be an investor.