As we enter the second half of 2021, the world can celebrate a number of accomplishments and goals. In hindsight the coordination of world citizens to social distance and make behavioral adjustments to mitigate the spread of COVID-19 was astonishing. Additionally, the speed of discovery,production, and distribution of the vaccines is simply without precedent. It was truly a valiant and coordinated effort. In terms of finance, global economies are emerging from a sharp and deep recession – but are recovering with vigor! COVID motivated global central banks to “give it their all,” injecting unprecedented amounts of money into the system at a rapid-fire rate. This, coupled with a tremendous amount of pent-up demand and savings, is driving a swift recovery in economic growth and general consumer optimism. Astute investors should ponder the longevity of this recovery, the bull market in stocks, and the effect of inflation and interest rates, each of which will affect our management of your assets. Let's “unpack” each of these important subjects.
Thus far we have entered a“roaring 20s” model economic boom. In the US the Federal Reserve, along with the US Treasury, has injected more funds into the economy than during the Great Recession of 2008 – it has worked like a “silver bullet.” Currently, US economic growth is running at a 6% annual rate which is a figure not seen since the 1960s! Global growth is running hot and central banks have not shown much sign of letting up with their generosity. It is important to note, as James’ first book The Journey to Wealth clarifies,recessions bring about new business cycles, economic expansions, and bull markets – that often last 8-9 years. So in the absence of another acute variant,or central bank policy blunder, we may be in just the early innings of this new business cycle and bull market.
Global Equity Markets
The backdrop for stock investing is healthy, as stated above, here in the US as well as overseas. As global investors we continue to see excellent opportunities in a myriad of market sectors, and what interests our team is the fact that stocks, in general, are reasonably priced – particularly concerning future earnings growth. Though it has already been a great rally from the market lows last spring, stocks as a whole are not overpriced and, in certain sectors, we would argue that there is tremendous value.
Inflation and Interest Rates
It has been so long since the world has seen economic grow that these levels that we think some investors require a bit of re-educating. Ever since the Great Recession of 2008 the world has experienced anemic economic growth and what comes with it – historically low interest rates and non-existent inflation. However, the strong growth we are experiencing today puts upward pressure on both inflation and interest rates. Though many commentators view inflation as bad news, we embrace it as good news. Inflation is a sign of strong growth. With our investment style we can, and have, adjusted your portfolio to be an“inflation beater.” Inflation also decreases the value of the national debt in real terms, making it easier to pay back. If dollars are worth less, then the amount of debt that needs to be repaid is less. Companies with net liabilities (mostly cyclicals) will also benefit from this. In terms of interest rates, one should prepare for higher, rather than lower, levels of economic growth that can continue to be robust – which we are hopeful for. Higher rates ahead would continue to negatively affect bond funds. This has already begun to occur across many bond funds with longer maturities, and there is more pain on the way should rates move upward, hence our focus on individual bonds as opposed to bond funds – a strategy that has worked well for you while rates rise. As the business cycle continues to mature from recovery to full expansion mode, it would be great to see interest rates at more normalized levels: a 10-year US Treasury at 4% and money market returns at closer to 3%, for example. This type of environment would be very healthy for investors who need income and want the safety of bonds and money market funds.
Attractive Market Sectors
In terms of the stock market and attractive sectors here and overseas, we continue to see great value. The strong economic growth and re-opening is “flipping the switch” back on for industrial, financial, raw material and consumer discretionary companies. We have had no problem finding great ideas at reasonable prices. At the same time, larger tech stocks have underperformed these more economically sensitive market segments in recent quarters. This presents an excellent opportunity to own some of these great global technology companies at great valuations. We would suggest that the back half of 2021 will be kind to the broad market and include technology as one of the better performers.
Volatility – More on the Way
It is common in the early stages of a bull market that stocks experience an upward trajectory with very low volatility. This has been the case for the past year. Going forward ,investors should expect continued market advances but with more normal volatility. Bull markets often experience a few corrections of 8-11% per year, however,we haven’t seen one since late last year. It is important to keep this in mind to prevent ourselves from being “lulled” into this abnormally smooth upward path and thus psychologically unprepared when more normal market volatility presents itself.
Active Risk Management
We are fascinated and optimistic by this economic and market environment and look forward to capturing further upside. However, if any of the positive data points and metrics that we have expressed begin to deteriorate, we stand ready to mitigate any significant downside risk through our Active Risk Management process. This method includes the flexibility to reduce your stock exposure, sector management, and the use of carefully placed stop-loss orders.
We hope that you find this update helpful. Please let us know if you have experienced any significant changes in your finances or have questions regarding your financial planning or portfolio.
Thanks again from the entire team for your continued vote of confidence in our work.
Your Team at Main Street Research
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