Please note: This update was prepared on Friday, July 23, 2021, before the market’s close.
Earnings optimism overshadowed a surprising jump in the number of people applying for unemployment this week. That same surge in sentiment outweighed investor concern over the spread of COVID-19’s delta variant among the unvaccinated and its potential drag on economic recovery.
Earlier in the week, it looked like Monday’s 2% stock market drop might be the opening ceremony for a long-overdue correction. But the aforementioned strong corporate earnings sparked a midweek rally and the S&P 500’s best two days in as many months.
To be honest, we view periodic market pullbacks as a healthy thing. While a 10% correction can seem unsettling, we think that a double-digit decline would take a lot of froth out of the markets and maybe send some speculative “investors” scurrying for the exits, leaving behind bargains for the rest of us. And remember, U.S. stocks have experienced an average 14% intra-year decline over the past few decades, so even a 10% decline would simply be a normal retrenchment in the course of the long bull market.
As for the delta variant: At the moment it’s the fear of escalating infections rather than a tangible economic impact that is roiling some traders. Whether this leads to another economic slowdown is the question. As devastating as pandemic setbacks are in terms of the human toll, today’s U.S. economy is far better equipped and, sadly, more experienced than ever in how best to bear them. We’ll keep a watchful eye out, but for the moment we believe the economy will continue to grow in the coming months.
Monday’s hiccup aside, stock markets are on course for a week of gains and possible record highs atop a year laden with them. On a total return basis, the Dow Jones Industrial Average is up 14.9% for the year through Thursday, while the broader S&P 500 has gained 17.2%. The MSCI EAFE index, a measure of developed international stock markets, has returned 8.6% through Thursday. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.39%, up from 1.12% at the end of 2020. Overall, the U.S. bond market has declined 0.6% year-to-date.
Inflation Can’t Take the Air Out of Earnings
Second-quarter earnings season is in full swing. Almost 90% of the 73 S&P 500 companies that have reported so far have exceeded already lofty expectations; many have doubled profits from a year ago. Of course, as we’ve cautioned when looking at economic data, year-over-year comparisons should be taken with a hefty pinch of salt due to the “base effect”—earnings are no exception.
The rosy picture coming from most boardrooms hasn’t knocked out the inflation debate on Wall Street. The inflation theme and questions about how transitory it will be remains on the minds of corporate executives, policymakers, traders and investors.
The Fed’s Next Fete
Speaking of inflation, the Federal Reserve is gathering next week for a regularly scheduled two-day meeting. The central bank is currently trying to thread the needle of supporting the economic recovery without letting inflation run amok.
Like the rest of us, the Fed heads have witnessed a bounceback from what, this week, officially became the shortest recession on record. According to the National Bureau of Economic Research, the official arbiter of these things, the COVID-19 recession lasted just two months—March and April 2020.
Fed Chair Jerome Powell says next week’s confab will focus on when, and how fast, to pull back on the bank’s $120 billion monthly purchases of Treasury and mortgage securities—the first step in ending bond purchases entirely.
The central bank has vowed to leave interest rates at their current near-zero range until the bond-buying program is wrapped up. Minutes from last month’s meeting showed that most policymakers expect at least one rate hike by 2023 and are willing to tolerate inflation that may temporarily outpace the Fed’s 2% benchmark.
In our view, the supply-demand imbalances fueling today’s higher inflation will eventually work themselves out. But the combination of a supportive Fed and spending programs from Congress suggest that inflation may still run hotter than it has in the past two decades. Of course, that’s a low (inflation) bar to hurdle, and it doesn’t point to an out-of-control run-up in prices.
Register for Our Quarterly Webinar Now!
You are invited to participate in Adviser Investments’ Third-Quarter Webinar, Rocket or Rollercoaster: Where Will the Markets Go From Here? The discussion will feature commentary from Chairman Dan Wiener and Director of Research Jeff DeMaso. Additional insights and answers to your questions will be provided by members of our investment team.
This week’s reader question is about asset allocation: Is the 60/40 approach still a smart investment strategy? If so, are bonds the right balance to stocks in this environment or are there other/better options?
Jeff DeMaso, Director of Research, had this to say:
The short answer: Yes, it is still a sound investment strategy.
Today’s headlines seem focused on pronouncing the classic balanced portfolio (60% stocks and 40% bonds) as outdated because the return prospects for bonds are, well, uninspiring. But you only need to look back to Monday—when stocks were down some 2%—for an object lesson on bonds’ role as portfolio shock absorbers. Why? Most bonds and bond funds rose, however fractionally.
Bonds aren’t intended to inspire; they’re designed to be dependable. When you buy a bond, you know with absolute certainty what the return will be over the life of that bond (unless it defaults). So, for example, if you buy a 10-year Treasury bond with a yield of 1.3% today, you’ll earn 1.3% annually over the next 10 years, at which point you’ll recoup the face value of the bond. That’s the dependability factor you don’t get with stocks.
The same principle applies to bond funds. With Vanguard’s Total Bond Market Index fund yielding 1.3% today, you can reasonably expect to earn 1% to 2% per year in that fund over the next five to 10 years.
Clearly, compounding at 1% to 2% over the next decade isn’t going to be the growth engine driving your portfolio’s value higher. However, the primary role of bonds in your portfolio is not to produce returns. If all you want is growth, you should be all-in on stocks, understanding there are no guarantees. But not everyone can (or wants to) stomach the ups and downs that come with putting 100% of their portfolio in stocks. And that’s where bonds come in.
Bonds have remained a reliable offset to stocks in a diversified portfolio—even in the low-yield environment we’ve witnessed over the past several years. The same can’t always be said of so- called alternatives like real estate or commodities.
Let’s look back to the first quarter of 2020, when the COVID-19 pandemic led to a panic in the financial markets. As Vanguard’s 500 Index fund fell 20%, the firm’s Total Bond Market Index fund gained 3%.
If we consider some of Vanguard’s funds that focus on differentiated investment objectives—Market Neutral, Commodity Strategy, Real Estate Index and Alternative Strategies—they all fell between 5% and 24% during the first quarter of 2020. I wouldn’t call that a successful offset to the drop in stock prices.
I’ve said it before: Adding complexity to your portfolio doesn’t automatically lead to better investment returns. Keeping it simple often leads to more predictable and reliable outcomes.
Financial Planning Focus
A Long-Term Care Insurance Checkup
As an Adviser Investments client, you’re accustomed to taking the long view when it comes to financial planning. That’s a smart move given that medical advances mean we’re living longer than previous generations.
Even though a recent report suggested life expectancies have actually fallen by 18 months, the facts are still sobering: A person turning 65 today has a near 70% chance of needing long-term-care (LTC) services at some point. And with a room in a private care facility averaging more than $100,000 a year, the cost is consequential. Medicare and supplemental insurance only pay for “medically necessary” nursing or home care but not the more involved (and expensive) daily needs such as bathing and dressing.
Fortunately, you can protect yourself, your family and your financial legacy with LTC insurance. It covers a broad range of services that other insurance won’t, from home health care and modifications (e.g., wheelchair ramps) to assisted living and residential care.
If you are interested in LTC insurance, here are five key factors to consider:
The track record of the insurer. The insurance company you choose should have a high credit rating—look for an “A” rating or better on ambest.com and a record of on-time payment of claims.
How benefits are paid. Benefits can be paid three ways—reimbursement, indemnity or cash. A reimbursement policy will pay a percentage based on the amount of your bill or the daily limit on your policy, whichever is less. Indemnity plans require proof of services but pay the full daily benefit regardless of the cost of your care. Cash plans offer the most flexibility but are also the most expensive. Once you qualify, the daily or monthly benefit is paid to you without any restrictions or receipts. If you expect to receive care from a friend or relative, the flexibility that cash policies provide may be the way to go.
How the plan is administered. It is important to understand not only how much your benefits are worth, but also how long they will last and whether they are paid out monthly or daily. Monthly benefits are becoming more common because they afford greater flexibility if you don’t need the same level of care every day.
Length of waiting period. The “elimination period” is the number of days you must wait before a policy starts paying—90 days is most common. To minimize premiums, consider an elimination period that starts paying you back after you’ve used a reasonable amount of your personal assets.
The impact of inflation. Private nursing home costs have risen about 62% over the last 16 years and costs of assisted living facilities are up 79% over the same period. If you are purchasing a policy when you are young (say in your early 60s), make sure your benefits include inflation protection.
If you would like more information on LTC insurance as part of your comprehensive financial plan or want help evaluating your current policy, please contact your wealth management team. As The Planner You Can Talk To, we’re always happy to help.
The Federal Reserve’s scheduled two-day meeting concludes Wednesday afternoon with a press conference by Chair Powell—likely the focal point of market momentum for the week ahead. Next week also brings useful reports on new home sales, home prices, durable goods orders and inflation in addition to consumer confidence, spending and personal income and savings.
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 23, 2021, before the market’s close.
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