Markets Update | What to Expect in the Second Half of 2021

In our latest Markets Update, the Main Street Research team looks at what to expect in the second half of 2021. Our team discusses lessons from past recessions, an update on the fixed income market, an overview of a sector analysis, and some highlighted individual securities that are in your portfolio. If you think someone would benefit from this update, please do not hesitate to share, the links are at the bottom of this page. This update is available in video and an audio only format, a transcript is also available.

An audio only version is available, and can be downloaded for offline listening.

Markets Update

James Demmert: James Demmert, founder and managing partner,

Benjamin Armellini: Benjamin Armellini partner and portfolio manager,

Aaron Stern: Aaron Stern partner and portfolio manager,

Lily Taft: Lily Taft portfolio manager.

James Demmert: Welcome again to another market update from our team at Main Street Research and we're excited to chat today about the second half of 2021. Wow. Look where we've come the last year. It's been pretty incredible. It's been a fascinating market environment, and we have lots of interesting things to share with you today, and I'm going to take the lead and then let a couple of my teammates share some more in-depth thoughts, not just about equities, but also fixed income.

And we'll talk about some of the themes in our investment portfolios have been so successful over the last year. We are in midst of now a full-blown economic recovery coming off of the COVID crisis. What we called a vaccine induced new business cycle is alive and well. And as you're probably aware equities have come up dramatically from the 40% decline that we experienced last spring, we all knew that the vaccine would cure the recession.

But the government funding on top of it has not just caused a normal recovery, but a roaring recovery. And we agree with lots of other commentators who have, who have likened this to the, the last century's  twenties and another roaring twenties is ahead of us. I think that's the most important question today, as we think about all the fed and fiscal stimulus, the vaccine doing its job.

And also the pent up amount of demand coming to the economy. We can see this economy growing at this point, still at 6% annual growth rate. We haven't seen that kind of growth rate since the sixties. So this is very real. And that's why we're seeing some inflationary pressures, hard to ignore, all the media attention, which is real about lumber prices, oil, commodities, raw materials.

So what you get with booming recoveries is you get inflation. The best way to beat inflation, if anyone forgets what that's like, it's a stock market. Stocks outperform inflation. It's one of the best tools to mitigate inflation risk. So inflation is just a sign of this roaring economic recovery. And I think what, what is on many investors minds today is how long can this last.

You know, is this a short-term phenomenon? Whereas this got some legs and, and our team thinks that this has got legs. You know, I would say one thing for all my clients and anybody watching this, that the recent trajectory is significantly higher than normal.

So as the bull market continues and we think it will, we suggest, that investors get used maybe a trajectory that isn't quite so steep and generous as we go forward. And probably more volatility, you know, the, in the last year, the biggest volatility we've seen is three or 4%. And for those of us that know the bull markets typically declines, normal corrections are eight to 10. So I would suggest that the bull market continues, but bumpier, it may be not quite as dramatic on the upside.

My last comment. And I think it's maybe one of my more important comments is that. Can  this bull market lasts longer than the past year. And we would suggest absolutely! You know, one of the things you can see from this long-term chart the stock market is that when you get recessions COVID or not, it's the same old recession like we've had now.

Usually it's a restart of the business cycle. And if you look backwards, you can see that most of these recessions, gosh, that first year was just the beginning and often these are seven to nine year business cycles and bull markets. So we would suggest, yeah, maybe more volatility but this market's got ways to go.

And my last comment, is really related to what are we going to do if we're wrong? And I think that's an important part of why we add value over the long run, you know, there's risk out there maybe we can't see one of them that we can is the variant. We would suggest that that may be a significant risk here.

So just keep it in mind if a variant comes along and the economy has to be closed down again, our team has got that active risk management process intact. What does that mean? That means we can reduce the amount of stock, very flexible about doing that to mitigate the risk. Let's stay in those healthy sectors, avoid unhealthy and let's use those very important stop-loss orders.

Remember they're not meant mitigate short-term declines or shallow declines. They're meant to mitigate catastrophic losses like 2008 or last springs, big 40% sell off. The active risk  management is always in place on your portfolio that we wanted to remind you of that.

But other than that, we think that it's up to the right, maybe a little less trajectory and maybe a bit bumpy. And the fed might have something to do with that. We we might hear from the fed thinking about raising rates, at some point.

With that, I'm going to turn it over to my colleague, Benjamin. Who's going to share some thoughts about the fixed income market

Benjamin Armellini: Appreciate that James.

So what we're looking at here is a chart of the 10 year us treasury yield and over the past, really 14 months, it's echoed a similar story to equity markets of this global recovery.

What's been interesting is at least in the short-term we're seeing the really credit markets starting to whistle slightly different tune as yields have fallen. And what that means in plain English, is that part of the credit market is pricing in more transitory growth and inflationary level, maybe that akin to pre pandemic levels. And that to us just seems too pessimistic.

Given the fact that the federal reserve is committed to keeping interest rates lower for longer. Although of course in time, and certainly with inflation, they will need to start raising rates up. Inflation is something that is healthy and we're starting to see really priced into fixed income markets and could also be culprit here.

One of the remedies in a lower interest rate environment, keeping in mind here that yields historically are pretty low right now, are using some fixed income alternatives. So thinking creatively beyond just traditional credit markets instruments, such as preferred stock, maybe parts of the real estate market. have

I've really out well for our client base and our somewhere, again, credit markets tend to heal over longer periods of time that we'll continue to leverage.

A source of pain a lot of investors, I know the next slide chose to articulate this well , is what we're seeing as the economy does continue to heal as rates are priced higher over time. And as inflation continues to be baked into financial markets, and that is really bond funds where you're seeing these two to maybe three, 4% yields in the fund.

What's happening there as they tend to hold long duration bonds, which simply means that those underlying instruments mature in 2030 years. And it's just a teeter-totter as interest rates move up, bond prices, particularly those longer duration bonds get compressed.

So we've seen a number of those down anywhere from six to maybe 10% year to date, which only continues to validate our strategy, understand what you own in the credit markets.

Make sure that you're managing that risk by winning bonds that are maturing credit cycle and let's keep our costs low. There's no point in creating a layering of fees.

So with that in mind, I thought it might be helpful to transition over to Aaron to discuss some of our sector analysis.

Aaron Stern: Thanks, Ben as James said, 2021 so far has been pretty good to stock market investors with the world index now up over 12% halfway through the year. And as you see, while every sector is up year to date, not every sector has performed equally.

Two of the most cyclical sectors, energy and financials are easily the top performing sectors while the more defensive sectors like consumer staples and utilities have had relatively little return.

Information technology, the big mega cap tech stocks have done pretty well at 15% year to date. But it hasn't really been the big, giant technology names that you might expect leading way more recently, it's been really about the cloud companies the DocuSign's and the Shopify guys that have been leading the way

more recently really exciting news with the recently agreed upon infrastructure bill. This should continue to generate great returns in sectors like industrials, raw materials and communication services. I think companies like caterpillar tractor, Schneider Electric, new core steel are really going to reap the rewards these potentially lucrative contracts is infrastructure comes back into play.

Many of the sectors in your portfolio will also fare pretty well given rising interest rates and inflation, if  that does come to fruition. But as Ben mentioned, we feel rates going to be kept low for another year or more.

We haven't really had a broad market correction, as James said, really since last year, we've had some corrections along the way, as you can see on the chart on the left the top line energy been pretty volatile.

Technology's had a couple of pretty noticeable corrections so far this year, and more recently it's been the financials and materials that we've seen some corrections. And we view these as opportunities to get more invested in these grades et cetera and we feel that barring any further shutdowns due to COVID or the feds raising rates too soon or too fast, we'll continue to seek growth across these more cyclical sectors.

And if we begin to get experienced greater than normal volatility, we're prepared to continue to gently rotate into the better performing sectors and may potentially lose some stock due to our active risk management, including stop-loss orders. Lily's going to chat about some of the stocks and themes that are in your portfolio today.

Lily Taft: Thanks Aaron. Now that we've gotten some color on the individual sectors, we can take a look at the companies that we've selected within those sectors. So, for example, some of the cyclical names I'm excited about includes Total, which has just rebranded as Total Energies to encompass its renewables business.

Siemens is also completely re-imagining the infrastructure of cities to reduce traffic and carbon dioxide emissions. These are all obviously important things consider as our countries carries out this infrastructure bill.

Deutsche Post is another one over in Europe. They're the parent company of DHL. Like all shipping providers, DHL had quite a busy pandemic. We all began to order online a lot frequently and it's encouraging to see their business continue at a pretty fast pace as we stick to some of those habits that we picked up while being stuck at home.

Of course, amazon and video game manufacturer, Activision Blizzard are also benefiting from new habits and experiencing pretty sticky or inelastic demand as some investors might call it.

So you might have noticed that a lot of these companies that we highlighted are based in Europe, and that's because you're right is poised to grow at levels that we have not seen in a very, very long time. So it's times like these, when we're really grateful to be international investors.

Of course, we're not going to forget about some of our favorites here at home, particularly tech, another great sector that Aaron mentioned. Tech definitely isn't going away anytime soon. And current data has only reinforced our convictions on technology and particularly a small sleeve of the portfolio we like to call the innovators and disruptors here on this slide.

These are the companies at the precipice of new technologies and new business processes. So, you know, if we think about the technological change today. It really feels consumers and businesses are evolving at a pace that seems faster than before.

So we're glad to have these types of modern companies represented in the portfolio. And like I said, the one thing that we can be certain about in the stock market is change, not,  a lot else.

But all innovation and entrepreneurship really comes from addressing real-world problems which do we think all of companies are doing so, For example, Shopify, is really empowering small businesses to create their own websites, sell their products on customized pages, and they can do this for as little as 30 bucks a month.

So really amazing technology, empowering entrepreneurs square, also empowering people and their small businesses to transact quicker and easier. We all know that small business is a huge part of the economy and any technology to get them online and growing is increasingly valuable. So we're proud to have captured it.

All the sector themes that we talked about as well as these upcoming technology themes represented here. So we think we've created a really diversified, intentional portfolio of companies with great competitive positioning. And with that, I'll hand it back to and thank you all for listening.

James Demmert: Yeah. Thanks lily. Thanks Aaron and Ben, and thanks from the whole team from all of us here at Main Street we're always feel honored to be the custodian of your wealth.

And if you have any questions about today's presentation or anything has changed in your financial life and let us know if you have any friends or family or colleagues who might be interested in our work also let us know.

And thanks again for taking the time to allow us to share our current thoughts about the second half of 2021. And we'll look forward to seeing you soon.

****The companies listed represent the largest holdings as a percentage of total assets under management by Main Street Research. Securities identified and described do not represent all securities purchased, sold or recommended for client accounts. The viewer should not assume that an investment in these securities has been or will be profitable****

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