Summer 2021 Commentary

July 15, 2021


The second quarter continued the terrific rally that began over a year ago. As COVID-19 cases and deaths continue to plummet, the reopening of the economy and rapid return to normal shows no signs of slowing. For the year, the S&P 500 has gained 15.3%, adding to last year’s strong showing of 18.4%. From the market’s pandemic lows, the S&P 500 has risen an astonishing 92%.

S&P 500 summer 2021
*This graph is not intended to recommend any investment or investment activity.

As many economists have predicted, the economy has picked up quite a bit of momentum in recent months. As more Americans have become vaccinated, and restrictions have been lifted, consumers have returned to restaurants, vacations, and other pre-pandemic activities. Travel has rebounded sharply, and by the Fall, it is expected that most of the economy should be back to pre-pandemic levels. GDP is expected to grow 4% this year and next, which is much higher than the average of about 2.5% in the previous decade.

Despite gains in the economy, unemployment remains at the elevated level of 5.9% versus the pre-pandemic low of 3.5%. In many sectors, particularly in dining and hospitality, businesses are having a very difficult time rehiring their workers. There are many factors causing this disruption; some workers have moved on to new fields, others are nervous to resume their jobs due to lingering virus concerns, while others are receiving enough from expanded unemployment benefits that they don’t feel the need to work, at least for now.

An effect of the dislocations in the labor market has been a spike in wages, which is one of the factors that caused inflation to post its highest reading since 2008. The Consumer Price Index registered an annual gain of 5% in May, fueled by higher energy and used automobile prices. Oil fell to $11 per barrel last year and has since rebounded to over $70. A lack of computer chips has stalled new car production, driving prices higher for used autos, in some cases higher than new autos. Fed Chairman, Jerome Powell, has characterized these inflationary forces as “transitory,” and we mostly agree.

There is a significant measurement issue distorting recent price data. The year-over-year readings compare current prices with an especially weak period when the pandemic and shutdowns were in full swing. When comparing current price levels to pre-pandemic prices, the rise appears far less dramatic. Even with the recent spike, the average rise in CPI for the past two years is only 2.5% per year, which hardly indicates runaway inflation.

Further evidence of calm about inflation can be found in the bond market. As fears have risen among strategists, bond yields have actually trended lower. Ordinarily, when bond investors expect higher inflation, they require higher yields to offset the risk. The benchmark 10-Year U.S. Treasury yield has declined from a high of 1.75% in March, to 1.44% at the end of the quarter, and has continued downward. Given the decline in yields, bond investors (who are generally considered the “smart money”) don’t appear to be particularly concerned about inflation. We, too, will remain calm until there is better evidence that inflation is becoming a more serious long-term issue.

The larger long-term concern has been the massive amount of deficit spending that has occurred as a result of the pandemic. In combatting the crisis, leaders borrowed from the playbook created during the 2008 financial crisis and flooded the economy with liquidity. The difference this time was they acted much faster and much more aggressively. The effect has been an increase of the national debt from roughly 80% of GDP to about 100%. The most obvious way to reduce the national debt will be some combination of spending cuts and tax increases. Not surprisingly, there hasn’t been much evidence that our leaders are willing to cooperate with one another to find good long-term solutions to our growing debt problem.

As we enter the second half of the year, the market has climbed to new all-time highs, and at the same time has remained exceptionally calm. The largest drop in the S&P 500 this year so far has only been about 4%. Given that on average the market declines 14% at some point during the year, the sailing has been unusually smooth. Although the economic outlook remains very constructive, we wouldn’t be surprised by a sudden bout of volatility before the year is through. That said, our expectations for market returns remain positive for the foreseeable future.

Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.

Owen Murray, CFA
Owen Murray joined Horizon Advisors in 2005. As a core member of the wealth management team, Owen is principally involved in investment research and portfolio construction.