July 2021 - The Movie Sequel Market
By Kyle M. McBurney, CFP
Managing Partner at Highland Peak Wealth
Let us begin this month’s newsletter with a quick thought experiment.
Take a moment, if you will, and think about your top three or four favorite movies. Ready? Of those great flicks, did any of them have a sequel? If so, how did that sequel compare to the quality of the original?
I love the movie Airplane!. It is a comedy classic that’s still as funny as ever. Shirley, you all agree with me. No? It looks like I picked the wrong week to quit Dad jokes.
Airplane II: The Sequel had its moments but overall was just okay. Like many movie sequels, it does a fine job of keeping you entertained but lacks the magic and vigor of the original. Please stick with me; this will all make sense later.
Wednesday’s close represents the halfway point on what has been a very positive, exciting year. Stocks finished the first half of the year with solid gains across the board – fueled by economic recovery and ample liquidity. The S&P 500 is up 15%, with the Dow Jones Industrial Average right behind at 12%. Even better, small-cap stocks, often a barometer of investor confidence and risk tolerance, leads all indexes up a whopping 17.5% year-to-date. International stocks continue to trail, but investors shouldn’t be overly disappointed as both developed and emerging markets indexes have thus far gained 9% and 7.5%, respectively.
A solid second quarter for stocks marks the fifth consecutive quarter of gains, the longest such streak since 2017. Corporate earnings have been stellar, hiring continues to improve, and recent readings of small business-owners’ confidence and CEO Confidence have bounced back well above their pandemic lows.
Investors should be overjoyed. However, investors and money managers everywhere grow anxious as the outlook grows increasingly cloudy and future returns harder to gauge.
Welcome to year two of a bull market: usually pretty good but lacking the force of the first. Does that sound familiar? The second year of bull markets, like movie sequels, tend to be subject to more pressure, debate, and nitpicking.
Investors head into the second half with plenty to consider. Concerns over lasting inflation, diminishing stimulus, and the growing possibility of the Fed raising rates sooner than expected will undoubtedly lead to some bumps along the way. Even as stocks climb, there is mounting anxiety that future gains will be harder to come by. With markets trading at 21 times earnings – well above the 5-year average of 18 – it is admittedly hard to find pockets of value.
As a reminder, there is always something to worry about with markets. Markets advancing in the face of pessimism is the norm. Markets are famous for climbing a “wall of worry.” For those who remain nervous, let’s revisit Airplane! when the main character, Tim Striker, experiences a bit of in-flight bumpiness:
Passenger: Nervous?
Tim Striker: Yes
Passenger: First time?
Tim Striker: No, I’ve been nervous lots of times
Despite the concerns, as we were at the beginning of 2021, we remain bullish, albeit somewhat less enthusiastic. A cocktail of economic growth and elevated levels of money supply (M2) continue to reaffirm our belief that stocks remain the best game in town. This isn’t to say that we don’t expect some bumps along the way; we certainly do. But, as history illustrates, choppy trading and more muted gains are standard in year two of a bull market.
We look forward to discussing, debating, and writing about what should be an exciting second half of the year. Of course, we will keep you updated every step of the way.
Fixed Income Overview
Outside of equity markets, fixed income returns have been a challenge. Pressured by higher rates and inflation concerns, fixed income has been the one blemish within a well-diversified portfolio – with a good portion of the bond world negative to start the year. Moreover, while we do not expect the hyperinflation of the ’70s and ’80s, higher inflation levels (compared to the last decade) are likely to remain. As such, bonds will likely prove to be less of a true stalwart within a well-diversified portfolio than it has been in recent memory.
Moving forward, we continue to maintain a short duration focus within our portfolios. We expect rates to continue to rise over time. Part of this rise is the natural rise that occurs in any healthy bull market as it matures. With rates rising, keeping our fixed income “short” in duration and maturity is our way to mitigate the impact and focus on reasonable income without unnecessary risk.
What We Are Watching – Growth vs. Value Reset
Client portfolios have soundly benefitted from our shift back in February from growth stocks to value stocks. To reiterate, as the vaccine rollout gained steam and as the economy began to reopen, we reduced our exposure to growth stocks (tech and “stay at home” names) in favor of economically sensitive value stocks. As a result, in 2021, sectors like banks, energy, and materials continue to outperform the broader market.
Markets in June provided a slight paradigm shift. Growth stocks had a fantastic month in June, outperforming their value counterparts by seven percentage points. Investors tend to favor growth stocks when they believe that economic growth will be harder to come by. However, the genuine concern of higher inflation is the accommodating response from the Federal Reserve. With a potential rate hike coming sooner than previously anticipated and corresponding slower growth, growth stocks gained steam in June.
The growth vs. value seesaw makes one thing clear - investors are undecided and unsure of the economy's direction. As such, we are modestly realigning client portfolios to be more balanced around our growth vs. value allocation. With a lack of a coherent market narrative across markets, our preference is to remain patiently balanced and let the market dictate the direction of our future growth vs. value tilt.
Of course, we will communicate any imminent adjustments in future iterations of this newsletter.
First Half Momentum
An above-average first half can be an excellent predictor of 2nd half success.
As is the case in the past newsletter, I enjoy looking back at history to predict future direction. So, after a solid first half in stocks, optimistic bulls should rejoice – as history is on their side. As the below chart from Strategas confirms, the first-half momentum typically carries over into the second half of the calendar year:
Source: Strategas
A few things jump out at me when I review these historical returns:
1) Outside of 1987, markets have been exceptionally strong in Q4
2) 3rd Quarter returns can be choppy
3) The results are a reminder of how strong end of year can be
Again, this is just one snapshot, and each market has its unique personality and makeup. Either way, it is hard to bet against historical trends and a market that has a lot working in its favor.
Chart of the Month – Taking a Look at Seasonal Trends
Source: Strategas
Allocation Update
Trading activity in June modestly altered our client portfolios. Outside of rebalancing our growth vs. value tilt, we have been hyper-focused on keeping portfolios aligned with long-term equity targets. Given the year's excellent return in stocks, our team is committed to ensuring that all portfolios are balanced and aligned. Warning signs still abound, of course. It wouldn't strain gullibility to think that a summer "pullback" or "pause" lays ahead.
To summarize, we would describe ourselves as unenthusiastic bulls. We maintain our overweight tilt to stocks and do not plan to alter that outlook any time soon. Given the vast amount of individual and corporate savings in the system, it isn't easy to bet against stocks. Also, our oft-used acronym TINA (there is no alternative) is alive and well. Fixed income markets struggle to provide meaningful returns, and alternative investments (commodities, real estate, structured solutions) will always remain but a modest part of our allocations. Until this dynamic changes, we will continue to cheer on the stock market from our humble perch.
Summer is in full swing at the McBurney household. AC units are crankin’, playgrounds are buzzing, and we have been spending as much time on the Cape as possible. If nothing else, the Cape has been a nice reprieve from some of the stickier temperatures around Boston (at least we were not Portland!). As it relates to our toddler, Teddy, it has been a challenge as summer camps have been slow to re-open at full capacity. My wife, Heather, has done a remarkable job of finding engaging activities around town. After all, it is all about diversification and diversion. Of all the fun activities, it has been gymnastics that has really taken hold of Teddy’s imagination. He has always been a physical child; he now tests every chair in the house to find the perfect "jump jump." Wish us luck!
We wish you all a very happy 4th of July. It certainly feels uplifting to have old traditions and gatherings back to normal. We have much to be thankful for. To end with a bit of humor, I will close with an amusing quote from the hit TV show Parks and Recreation:
History began on July 4th, 1776. Everything before that was a mistake.
Ron Swanson
As always, comments and questions are welcome. Have a wonderful summer.
Best,
Kyle M. McBurney, CFP®
Managing Partner
The opinions expressed herein are those of Kyle McBurney, CFP as of the date of writing and are subject to change. This commentary is brought to you courtesy of Highland Peak Wealth which offers securities and investment advisory services through registered representatives of MML Investors Services, LLC (Member FINRA, Member SIPC). Past performance is not indicative of future performance. Information presented herein is meant for informational purposes only and should not be construed as specific tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary, therefore, the information should only be relied upon when coordinated with individual professional advice. This material may contain forward looking statements that are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Referenced indexes, such as the S&P 500, are unmanaged and their performance reflects the reinvestment of dividends and interest. Individuals cannot invest directly in an index CRN02406-421226
