The second quarter of the year saw strong market returns once again, fueled in part by both a reopening economy and loose monetary and fiscal policy. That’s not to say that there haven’t been any hiccups along the way. Inflation concerns were stoked again when the May year-over-year rise in consumer prices hit 5%, the biggest spike in inflation in the last 13 years[i]. In response, the Federal Reserve increased its expectations for inflation this year while indicating that it may raise interest rates earlier than previously expected[ii]. The Fed maintains its position that inflation is transitory but concerns that inflation may be more long lasting have contributed to market volatility, nonetheless.
We can see the Treasury market ultimately giving the Fed the benefit of the doubt, as the yield on the 10-year bond reached a peak at 1.74% on March 31, before gradually dropping to end the quarter at 1.45%[iii]. As economists and market strategists intensely debate the prospects of sustained inflation, both equity and fixed income markets are for now accepting the Fed’s view.
Large cap stocks outperformed small cap in the second quarter, a reversal of the trend seen in the previous two quarters. Fueled in part by the uncertainty about the pandemic and the economy, the big growth stocks that did so well in 2020 saw strong returns this past quarter.
Small cap stocks still did well on an absolute basis for the quarter. Their outperformance in the first quarter was so pronounced that they have the largest gain by a good margin on a year-to-date basis.
Developed and emerging markets also had a strong quarter but underperformed large cap US stocks. The dollar weakened in the quarter, boosting overseas returns for US based investors. Varying vaccine rollouts in emerging markets relative to developed markets are creating additional hurdles for their economies.
Value continued to outperform growth in US small cap stocks and emerging markets, but growth stocks outperformed in the large cap sector, fueled by the big tech names that were hobbled in the first quarter. The rotation into either value or growth stock sectors seems to change with the sentiment about reopening economies, with value stocks being boosted by optimism and growth stocks benefitting from concerns about economic growth.
Bond markets reversed the trend seen in the first quarter as US investment grade bonds gained back about half of their first quarter drop. Municipal bonds remained relatively flat but still positive. Lower credit quality bonds, which tend to be more correlated to stocks, saw a meaningful rally in the second quarter as the search for higher yields continued. Emerging Markets bonds had the strongest rebound of the bond indices shown, driven in part by the weakening US dollar.
Just when as it looks as if we might have calmer waters ahead, something seems to stir the pot; while overall market volatility has declined since last year, there has been a lot of movement within the market, among sectors and styles.[iv] There is still much uncertainty in capital markets, but it seems that the good is generally outweighing the bad–and investors who have stayed with well-diversified portfolios have been able to participate fully.
[i] Guilford, G., 2021. U.S. Inflation Is Highest in 13 Years as Prices Surge 5%. [online] WSJ. Available at: <https://www.wsj.com/articles/us-inflation-consumer-price-index-may-2021-11623288303> [Accessed 2 July 2021].
[ii] Cox, J., 2021. [online] Available at: <https://www.cnbc.com/2021/06/16/fed-holds-rates-steady-but-raises-inflation-expectations-sharply-and-makes-no-mention-of-taper.html> [Accessed 2 July 2021].
[iii] Source: Treasury.gov.
[iv] Mackintosh, J., 2021. The Stock Market Hasn’t Been This Placid in Years. [online] WSJ. Available at: <https://www.wsj.com/articles/the-stock-market-hasnt-been-this-placid-in-years-11624740199?mod=searchresults_pos2&page=1> [Accessed 2 July 2021].
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