The S&P 500 rose to another record high during the second quarter as a substantial decline in COVID cases combined with a near-total economic reopening across the U.S. led to a surge in economic growth over the past three months.
Numerous positive developments helped the S&P 500 to a strong start in Q2. First, vaccinations in the U.S. accelerated in April, with daily jabs hitting a peak of more than three million per day by the middle of the month. Simultaneously, new daily cases of COVID fell from approximately 77,000 at the beginning of April to less than 60,000 during the end the month. Increased pace of vaccinations combined with the decline in new cases helped many states reopen their economies or prompted announcements of plans to do so soon. That signaled to investors a return to “pre-pandemic normal” was likely just a matter of time. Meanwhile, the Federal Reserve reiterated its support for the economy and promised not to remove any accommodation in the near term. That continued “safety net” gave investors confidence in the future economic outlook and the sustainability of the economic recovery. Finally, first-quarter corporate earnings were strong, as many U.S. companies beat earnings estimates. These factors helped stocks rally throughout the month, as the S&P 500 hit a new record above 4,200 during the final days of April.
In May the rally paused, however, thanks to uncertainty regarding inflation, the labor market and when the Federal Reserve would begin to taper its quantitative easing (QE) program. A disappointing jobs number implied the labor market might not be recovering as quickly as expected. That, combined with inflation metrics hitting multi-decade highs, elicited some concern the economic recovery might not be as strong as forecasted, and that a return of inflation might make the Federal Reserve begin to reduce accommodation earlier than previously expected. But after some volatility early in the month, it became apparent the lackluster job growth was more a function of a labor supply issue rather than availability of jobs, and investors came to believe that issue will resolve itself as the economy and society continues to return to pre-pandemic “normal.” Meanwhile, Federal Reserve officials reiterated their long-held position that any increase in inflation would be temporary and due to pandemic-related supply chain disruptions rather than a return to 1970s style inflation. Investors were comforted enough for stocks to rebound in mid-May and close the month with a small gain. Stocks resumed the rally in early June, as more state economies (most notably California) returned to pre-pandemic normal, measures of economic activity remained strong, and certain inflation statistics implied that inflation pressures were starting to ease. This possibly validated the Fed’s assertion that surging inflation is just temporary. The June Fed meeting provided a small surprise to markets, as it revealed that Federal Reserve officials began discussions about when to reduce the current quantitative easing program, while Federal Reserve forecasts showed interest rates could start to rise late in 2022, sooner than previously expected. Those two surprises caused some mild market volatility late in June, although ultimately investors remained confident the Federal Reserve will not remove economic support too quickly and the S&P 500 hit another record high during the last few days of the quarter.
In sum, strong gains of the second quarter and the first half of 2021 reflected continued government support for the economy combined with a material improvement in the pandemic. And as we start the second half of 2021, we are happy to say the world looks a lot more like it did pre-pandemic than for most of 2020, and that sentiment is supportive of risk assets going forward.
3rd Quarter Market Outlook
Markets reflected a legitimate improvement in the macroeconomic outlook during the second quarter as substantial progress against the pandemic helped underwrite the gains in stocks over the past three months. But that strong performance should not be taken as a signal that no risks remain, because the next three months will bring clarity on several unknowns including inflation, future Federal Reserve policy, and the pandemic.
Regarding inflation, some metrics in June implied the spike during the second quarter is starting to reverse, but that debate is far from settled. To that point, no one knows what trillions in pandemic stimulus combined with 0% interest rates and the Fed’s ongoing QE program will do to inflation over the longer term. If this sudden surge in inflation is indeed just temporary, we should see more conclusive evidence of that during the third quarter.
The Federal Reserve, meanwhile, has started the process of communicating how it will reduce support for the economy via reducing its quantitative easing program. The last time the Fed delivered that message, they triggered the “Taper Tantrum” of 2013, which saw stock and bond market volatility rise significantly; and it remains to be seen how expected removal of accommodation and an eventual increase in interest rates will impact markets.
Finally, despite significant progress against COVID-19 here in the U.S., the pandemic is not over. Vaccination rates in most countries lag behind the United States, and last quarter saw an explosion of COVID cases in India, and an outbreak in China. England delayed its economic reopening and both Australia and South Africa reimplemented local lockdowns due to rising cases of the “Delta” variant. Point being, as new COVID variants appear, countries have to respond. If markets become concerned over how variants impede a return to economic “normal”, that will cause volatility.
In sum, while material progress has been made in the United States, and life as we know it has returned mostly to normal, now is not time to become complacent. Economic and pandemic-related risks remain. As such, while the macroeconomic outlook is still decidedly positive, we should all remain prepared for bouts of market volatility.
At Brixton Capital Wealth Advisors, we are committed to helping you navigate this ever- challenging investment environment. Successful investing is a long-term journey, and even temporary bouts of volatility like we experienced during the height of the pandemic are unlikely to alter a diversified approach set up to meet your investment goals.
It’s critical for you to stay invested, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
The economic and medical progress achieved so far in 2021 notwithstanding, we remain vigilant towards risks to portfolios and the economy, and we thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you successfully navigate this market environment. Contact us with any questions, comments, or to schedule a portfolio review.