Jason Gunkel, CFP®, CFA, CAP®, Chief Investment Officer
August 6, 2021
The stock market, as represented by the S&P 500 Index, continued to climb in the month of July and reached new all-time highs. After a drop in the middle of the month caused by higher than expected inflation numbers, the market recovered to gain about 2.4%. The stock market is now up about 18% for the year.
Meanwhile, the bond market as represented by the Bloomberg Barclays US Aggregate Bond Index also rose during the month by a little over 1% as interest rates continued their downward trend over the last few months. The bond market is now only down -0.50% for the year.
The annual inflation rate, as measured by the consumer price index, rose to 5.4% in June, which is well above the Federal Reserve’s 2% long-term target. Investors continue to be focused on statements from the Fed for any indication that they will begin to taper their bond purchases as a start to slow down economic growth and inflation.
At the end of July, the Fed kept interest rates unchanged as expected and again did not state much concern about the rising inflation numbers. Overall investors viewed these statements as good news for the stock market.
More good news has come with company earnings reports for the second quarter that were released in July. Approximately 86% of companies have beaten their earnings estimates according to data from Bloomberg. However, annual earnings growth is expected to peak with the second quarter results as earnings bottomed in the second quarter of last year during the pandemic. As earnings growth declines, stock market returns tend to become more volatile, according to information from Schwab.
The U.S. Department of Commerce reported that Gross Domestic Product (GDP) grew at an annual rate of 6.5% in the second quarter, which was well short of expectations of around 8.5%, according to Yahoo Finance. However, investors seemed to view the report as positive since it was the second highest growth rate since 2003, and the U.S. economy surpassed its pre-pandemic peak.
As mentioned earlier, bond yields continued to fall during the month which has defied conventional wisdom. Typically bond yields rise when the economy is growing quickly, inflation numbers are rising, and the Federal Reserve could tighten their monetary policy.
It appears that investors are taking more of a long-term view that a potentially tighter policy by the Fed could dampen the outlook for the economy which generally causes interest rates to remain lower. This has been good news for bond investors in the short term who have seen their bond prices recover from lows earlier in the year. However, retirees would likely welcome higher interest rates in the long run to start earning more yields from their bonds.
The market will continue to monitor the delta variant of the coronavirus that continues to spread globally. The stock market fell earlier in the week when the CDC recommended that individuals wear masks again in higher-transmission areas even if vaccinated.
Given all of this information, the stock market rally still appears to have more legs. While economic and company earnings growth rates might be reaching their peaks, they are still likely to remain at record-high levels for the foreseeable future.
We could be near a turning point in the economy where different market sectors start to outperform. Our investment team will continue to monitor and make adjustments for our clients as necessary.
Actions by the Federal Reserve could slow the rally, but as long as inflation numbers start to decline with more supplies of goods (as investors and the Fed expect), we remain optimistic for the second half of the year.