Adviser Outlook, Third Quarter 2021 - Adviser Investments

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Adviser Investments Market Outlook

Adviser Outlook, Third Quarter 2021

Quick Takes

  • Reopening has fanned economic growth and stock market gains this year
  • Inflation is higher but it’s not out of control; we think the pace is likely to slow
  • With everything looking up, investors may be too complacent, a risk we’re watching closely

The reopening recovery rolls on. In the U.S. in particular, economic activity accelerated as COVID-19 restrictions were lifted thanks to vaccination success. Close to 70% of all adults in America have received at least one dose of the vaccine to date.

U.S. stocks have been on a nearly uninterrupted ascent that has seen the market almost double since the March 23, 2020 pandemic low. The S&P 500 has posted positive returns for five consecutive calendar quarters and hit 34 new highs through midyear 2021. There’s been hardly a jolt or rattle to shake investors—volatility has been unusually low this year, despite talk of large tax hikes and the spread of COVID-19’s Delta variant across the globe. We’re not certain how long the stock market joyride will last, but we’re expecting bumpier roads ahead.

The economy grew at a 6.4% annualized rate during the first three months of the year and early forecasts put the pace of expansion as high as 7% to 10% for the second quarter. The U.S. economy is too large to sustain those lofty growth rates, so this may be the peak of the economic snapback with continued but slower growth ahead.

We’ve seen a pickup in wages, job openings and hiring, though employment is still off 6.8 million jobs today compared to pre-pandemic levels. Workers are increasingly in the driver’s seat in this labor market, but there is still a gap between what businesses will pay and what workers are looking to earn in certain fields, making it difficult to fill positions quickly. In turn this is making it hard for companies to meet their customers’ heightened demands.

As we expected and advised clients to prepare for, the rapid economic rebound has driven prices higher. Inflation was 5.0% year-over-year from May 2020 to May 2021—the largest 12-month jump in prices since mid-2008. But even with that bump, inflation has averaged less than 2.0% annually over the past three years. We believe pricing pressure will begin to recede in the months to come. Not only will comparisons to deflationary periods a year ago fall out of the equation, but as supply and demand imbalances are resolved, inflation should ratchet lower.

The headlines may be making you fret over inflation and higher taxes, but one of the biggest risks on our radar that no one is talking about is investor complacency. Confidence abounds (the ongoing meme-stock phenomenon is but one symptom). A serious market shock could send traders running for the exits, steepening the downward trajectory of any pullback and possibly frightening longer-term investors. What could trigger a pullback? Trade tensions between the U.S. and China, the aforementioned Delta variant wreaking more havoc than currently assumed, further disruptions to the supply chain, Mother Nature, human nature (from wars to ransomware)—the list of possible risks goes on.

Despite this litany, we think the global economy has more room to run. In the U.S., we have yet to recover to pre-pandemic levels on a number of fronts, from gross domestic product (all finished goods produced in our economy) to employment and beyond. The passage of an infrastructure bill this summer could spur spending, create jobs and lay the foundation for a longer runway to future growth.

Second Quarter Review

  • U.S. stocks climbed in Q2, thanks to a reopening economy and monetary stimulus
  • Momentum shifted rapidly between value and growth stocks; energy climbed higher, while tech and communication services stocks were resurgent
  • The bond market generated a modest gain even in the face of higher inflation; yields fell over the quarter

Over the short term, stock markets are often driven by momentum. Assets that are doing well continue on that trajectory until something changes—be it sentiment, economic data or any of a slew of other factors. Over the past three months, momentum was particularly fickle. Beginning in late 2020, the economic rebound drove so-called value stocks to outperform growth stocks for the first time in years. But that outperformance wobbled during the second quarter as growth (think technology and consumer discretionary companies) and value (utilities, energy companies and industrials) stocks frequently traded leadership. In aggregate, growth outperformed value over the last three months after having lagged over the prior two quarters.

All of that said, we don’t chase ever-shifting trader sentiment. Instead, our longstanding investment approach heeds the fundamentals that drive markets longer-term: Earnings, interest rates and economic data.

Markets Continued Climbing in Q2
wdt_ID Index Q2 YTD 12-month
1 S&P 500 8.5% 15.3% 40.8%
2 MSCI U.S. Broad Market 8.4% 15.4% 44.6%
3 MSCI EAFE 5.2% 8.8% 32.4%
4 Dow Jones Industrial Average 5.1% 13.8% 36.3%
5 MSCI Emerging Markets 5.0% 7.4% 40.9%
6 Bloomberg Barclays U.S. Aggregate Bond Index 1.8% -1.6% -0.3%
Note: Ranked by Q2 returns. Performance numbers are total returns, reflecting reinvested dividends through 6/30/2021. Source: Morningstar.

However you slice the data, it’s been a good year to be a stock investor. The S&P 500 index returned 8.5% in the second quarter, pushing it to a 15.3% return year-to-date and a 40.8% gain over the last 12 months. Meanwhile, the Dow Jones Industrial Average hasn’t quite kept pace but was up a solid 5.1% in Q2 and has gained 13.8% this year, with a 36.3% return year-over-year.

Yield-producing sectors led the pack in Q2. Energy stocks benefitted from higher oil prices, gaining 12.6%, while REITs returned 12.0%. After lagging in Q1, tech and communication services stocks had a strong second quarter, gaining 11.5% and 11.3%, respectively. Utility stocks represented the lone sector out of 11 with a loss over the last three months.

U.S. Sector Performance
Ranked by Q2 Return

Source: Morningstar.

Overseas, developed markets in Europe and some emerging markets hit all-time highs in recent months. The MSCI EAFE and MSCI Emerging Markets indexes both returned 5% or more in Q2 and are up 32.4% and 40.9%, respectively, over the last 12 months.

If the going was good on the stock market side of the fence, bond investors could also breathe a sigh of relief over the last three months as the U.S. bond market returned 1.8%. (It lost 3.4% during 2021’s first quarter.) Over the period, the yield on the benchmark 10-year Treasury bond fell to 1.45% from 1.74%. Some market-watchers consider this an indication that the current spike in inflation will be transitory. If traders were worried about lower returns after inflation, they’d seek alternatives to bonds and prices would drop, causing yields to rise. (For more on our expectations for bonds, please click here.)

Our Outlook

  • The economy should expand throughout the summer as pandemic effects recede
  • Volatility could return and a pullback or even a bear market decline is possible
  • Following stocks’ recovery run, investors should reexamine their comfort with risk and adjust their portfolios or financial plans as necessary; Adviser Investments can help

Heading into the second half of the year, we are anticipating a more challenging market for investors and traders—a correction would not surprise us. That said, we also expect the economy to continue to expand, interest rates to be mostly stable, and better (and more reliable) earnings forecasts from companies as they face fewer public-health limitations and gain greater visibility into their future prospects.

Bolstering our economic outlook is the fact that restaurant dine-in guest numbers, TSA traveler traffic and hotel occupancy have risen to within 5% to 20% of their 2019 levels (after being 70% to 100% below them at the peak of the economic shutdown). We think this trend will continue as more and more people are vaccinated and venturing out into the world—usage of navigation apps has eclipsed pre-pandemic volume in recent weeks.

Meanwhile, the inflation experts at the Federal Reserve have stated that they are “talking about talking about” cutting back on stimulus or raising rates a little sooner than planned (in late 2022 instead of 2023). A lot can happen between now and then, but nothing we see indicates that inflation is out of control or beyond the Fed’s ability to manage.

We can’t predict the timing, but the stock market’s current bull run will eventually face a hurdle big enough to cause a setback. It could be traders taking profits or an external event—either way, pullbacks create buying opportunities for long-term investors like us and our managers. We quote this stat often, as it’s one to remember in good times and bad—on average, stocks suffer a 14% intra-year decline. So far in 2021, the biggest decline has been less than 5%.

Investors should always be prepared for a possible bear market. To be clear, we are not predicting a major crash or recession, but we’re not ignoring market history lessons. From the mid-1970s through the Global Financial Crisis in 2009, the average bear market (a decline of 20% or more) took 16.5 months to reach its nadir, and stocks took an average of 44 months (more than three and a half years) to recover their losses.

In contrast, over the last 10 years, including the pandemic’s one-month 34% decline, there have been four noteworthy market pullbacks (not all were bear markets). These lasted just over two months from top to bottom, with losses recovered in three and a half months on average. Recent history may have investors thinking it’s easier to make money in stocks than ever before—a form of recency bias that can exacerbate fear when the market cycle turns.

As always, our diversified, risk-aware approach is designed to perform well under pressure. The takeaway is not that we suggest moving to the sidelines because the next bear market might be nearer. Instead, the recent spate of strong gains affords you the opportunity to review your long-term risk tolerance, take stock of where you are relative to your investment objectives and, if necessary, revisit your financial plan to make sure the proper risk controls are in place. Adviser Investments is available to help you do just that—and we recommend doing so while calm markets foster calm thinking and analysis.

Personal Finance Focus

Important Estate-Planning Updates

It’s almost as certain as death and taxes. With the changing of the guard in Washington comes a host of new laws and regulations. Here are three estate-planning updates that could impact you and your heirs in the years ahead:

  1. Capital gains tax hikes. The Biden administration’s tax bill proposes creating a new tax bracket for long-term capital gains—if your income is over $1 million, your long-term capital gains rate could rise from 20% to 40%.
  2. Higher taxes on inherited securities. The very same tax bill also includes a provision that could raise taxes on inherited stock. Under the Biden tax proposal, the basis adjustment tax break (also known as the “step-up basis,” which gives heirs a potentially huge tax break for the sale of inherited assets) would apply only to the first $1 million of inherited wealth. After that, your heirs would owe capital gains taxes on the equities as if they had been sold during your lifetime. (For further details on these proposals, listen to this podcast from our tax experts: Biden Tax Hikes: What We Know Now.)
  3. Better financial aid treatment on education savings for grandkids. Starting in 2023, grandparents, aunts and uncles, or others outside the immediate family will be able to help with college costs without significantly reducing a student’s aid eligibility (under current rules, funds from 529 plans owned by anyone but a parent or guardian count as income in financial aid calculations). 529s were already a useful vehicle for estate planning; this change will make them even more so (read more here: All About 529 Accounts).

Talk to your financial planner to discuss this legislation, your estate plan and all of your financial planning needs—or give us a call. We can help.

Company News

Community Outreach at Adviser

Community Servings, a vital, local nonprofit providing nutritious meals to chronically and critically ill individuals and their families. They do this by developing customized menus to help recipients manage nutrition-related side effects of the medications they are taking. They also offer educational workshops to help people maintain and improve their health through diet and food preparation skills, and they run a job-training program for budding local chefs.

With pandemic restrictions lifted, our Adviser Cares committee was back in action with a visit to

During their shift, our five volunteers peeled over 300 pounds of carrots, 120 pounds of celery and more than 200 onions.

Thank you to Community Servings and our Adviser Cares volunteers!

This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

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