Please note: This update was prepared on Friday, July 2, 2021, before the market’s close.
This week had us counting up records as we counted down days to the holiday weekend.
While the S&P 500 index notched an all-time high each day this week, it’s been nearly two months since the Dow Jones Industrial Average reached new heights of its own. Driving the (admittedly slim) difference in performance between the two well-known benchmarks is the reemergence of tech stocks as market leaders. On the back of a court win, Facebook’s stock became the latest to cross above the $1 trillion market-cap threshold, joining Microsoft and fellow FAANGs Apple, Amazon and Google parent Alphabet in that rarefied group.
But it was jobs news that really held traders’ attention, with consistently positive data helping keep the equity markets trending up. Friday’s non-farm payrolls report exceeded economists’ expectations, setting up a strong close to the week. According to the Labor Department, the U.S. added 850,000 jobs in June (far more than consensus estimates of 706,000).
The jobless rate ticked higher, to 5.9%, but that may actually be a sign of strength, as more people voluntarily left their jobs (which typically only happens when workers are confident they can find a better-paying job). That said, there’s still room to grow—even as folks reenter the workforce and hunt for employment, the economy has 6.8 million fewer jobs (a number that’s shrunk significantly in recent months) than pre-pandemic.
Put it all together, and there’s still no sign of the rally slowing down. At the midpoint of 2021, the Dow Jones Industrial Average is up 14.2% for the year through Thursday, while the broader S&P 500 has gained 15.9% on a total return basis. The MSCI EAFE index, a measure of developed international stock markets, has returned 9.0% through Thursday. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.52%, up from 1.12% at the end of 2020. Overall, the U.S. bond market has declined 1.6% year-to-date.
Must What Goes Up Come Down?
Investors may be getting a bit too optimistic for their own good. A just-released survey from global asset manager Natixis suggests investors have lost sight of the risks inherent in the stock market. Respondents in the U.S. believe stocks will return 17.5% annually, after inflation, in the years ahead. We fear these investors are falling victim to recency bias—the tendency to extrapolate recent experience well into the future.
Consider this: The S&P 500 index has hit 35 all-time highs this year, and its path upward has been one of the smoothest glides in history. With the year’s first half in the history books, the index’s worst drawdown has been a mere 4.2% decline over 13 trading days through March 4.
To put that drop in context, take a look at the following charts. The first has more than 60 years of S&P 500 index history and shows the declines of years past and present; the second zooms in on the first six months of 2021.
Those spiky stalactites might look similar at first glance, but only if you ignore their scale (-60% vs. -4.5%). Widening our scope to even 18 months makes clear just how little volatility we’ve seen this year:
This is not normal. Stocks have been going up, up, up with nary a heart-quickening decline.
While the lack of volatility in the market isn’t ordinary, it’s not without precedent. We could be in line for another year like 2017, when the S&P 500 index was up 19% and its biggest drawdown was less than 3%.
But 2017 was far from typical—on average, you can expect the market to experience at least one 14% drop over the course of a year. And the smooth sailing of 2017 was followed by a more difficult 2018, which saw the S&P 500 experience a drawdown of 19.8% on its way to a -6.2% return on the year.
History and our experience tell us that we need to be prepared for a break in the current calm. At times like these, when investors expect after-inflation returns of 17.5%, it’s easy to forget that the potential for a double-digit correction is always right around the corner.
Where could pullbacks hit hardest? It could be the sectors or slices of the market that have risen the most in 2021—energy, small-cap and value stocks have all experienced big gains during the economy’s emergence from lockdown. Or maybe it’ll be those high-flying tech stocks with trillion-dollar market caps that bear the brunt of market headwinds.
We can’t give you a date to circle on your calendar. But there will come a time when traders who piled into the market are going to hit the exits fast and hard.
We’ll never bank on the assumption that the current rally is the status quo. Instead, our investment team is constantly discussing risks both obvious and hidden. We make investment decisions based on what we know, always with the goal of preserving and growing your hard-won wealth.
Podcast: Fighting Inflation Fears
Will inflation rise? How will the Federal Reserve react? Can it halt the recovery? Questions like these have dominated the financial press so far in 2021. Adviser Investments’ bond experts, Senior Vice President Chris Keith and Research Analyst Jen Yousif, sat down with Vice President and Portfolio Manager Charlie Toole to talk about what’s behind those headlines. They cover:
What inflation is
Why bond investors worry about it
What’s driving the big inflation spike we’re seeing now
Why we still think the inflation threat will fade in time
Understanding how inflation can impact your portfolio is essential for any fixed-income investor. Click here to listen, learn and prepare.
Financial Planning Focus
Reverse Mortgages—Myths Versus Reality
Reverse mortgages garner quite a bit of attention from the media—much of it negative. But that’s not the whole story. We’re going to separate the myths from the facts.
First, let’s define our terms: A reverse mortgage is a loan that allows you to access a portion of the equity in your home. But unlike most loans, you don’t pay it back month by month. Instead, your loan is repaid down the road, with proceeds from the sale of your home or by your estate.
You must be at least 62 years of age and have a large amount of equity in your home to take out a reverse mortgage (50% is a good rule of thumb, but that amount can vary depending on the lender, the mortgage balance and the value of the home). Proceeds can be taken as a lump sum, doled out in the form of fixed monthly payments or held in reserve as a line of credit.
Myth: The bank receives the title of the home as part of the reverse mortgage. Reality: The title stays in the homeowner’s name.
Myth: Your heirs will not inherit your home. Reality: If you have an outstanding reverse mortgage on your home when you pass, your estate will still inherit your home. At this point, the outstanding loan on the property must be repaid. Importantly, though, a reverse mortgage is a “non-recourse” loan, which limits how much your heirs owe:
If your heirs decide to keep the home, they will have to pay off the loan—but they can never owe more than the home is worth.
If the house is sold and the sale doesn’t cover the loan balance, the difference is paid by the Federal Housing Administration (FHA).
If the property is sold for an amount in excess of the loan balance, the remaining funds go to your heirs.
Myth: You will be forced out of your home if you don’t pay back the reverse mortgage. Reality: A reverse mortgage never needs to be paid back by the borrower. If you take out a reverse mortgage, you can remain in the property for the rest of your life without making any payments on the loan. However, you still owe property taxes and homeowner’s insurance. If those payments are missed, you could face foreclosure.
Myth: A reverse mortgage line of credit and home-equity line of credit are the same thing. Reality: While both can be used to tap into the equity of a home, there are some important differences. A home-equity loan needs to be repaid by the homeowner, typically over a five- or 10-year period. Reverse mortgage loans do not; the lender is paid when the house is sold or the estate settled. But reverse mortgages come with much steeper closing costs than home-equity loans.
Reverse mortgages make sense in certain situations and are the wrong choice in others. Call you’re an adviser if you have questions about whether a reverse mortgage is right for you or a loved one.
Strategy Activity Update
Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.
“Slow” is about the only word to describe the trickle of data to be expected over the holiday-shortened week to come. But we will get reports on the service side of the economy, updates on job openings and jobless claims, as well as info on consumer credit and wholesale inventories. We’ll also get the minutes from last month’s Federal Reserve confab.
As always, you can visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.
Please note: This update was prepared on Friday, July 2, 2021, before the market’s close.
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