Recovery Mode
The first half of the year started on solid footing. A rapidly recovering economy and strong gains in stocks boosted investor euphoria. After such a swift recovery in financial markets, the challenge now is staying grounded in your investment strategy when it feels like everyone else has lost theirs.
The economic recovery from the pandemic is in full swing. Economists expect 6.6% GDP growth for 2021. Fueled by government spending and reopening, output in the US will likely surpass pre-pandemic levels by the end of the year. If the year plays out as expected, it will be the fastest growth in GDP since 1984.
As the economy recovers, frictions and dislocations are showing up. Relative prices of certain goods have jumped, and businesses are struggling to find workers. Consumers are stomping on the accelerator, and the tires are spinning. There’s a lot of smoke, but the economy is taking off.
Already, some of the commodity price pressures have abated. Lumber prices are down 55% since peaking in mid-May. Overall, commodities registered a strong quarter and a solid first half performance. The strong performance of late in contrast to the last decade, characterized by oversupply in raw materials and generally declining prices for commodities.
Bond prices retreated year-to-date as interest rates rose. The 10-year Treasury yield topped 1.75% in March but settled under 1.5% by the end of the June. Corporate and inflation-linked bonds outperformed Treasuries, while municipal bonds were coveted for their preferential tax treatment.
If the year were to end now, the 12% gains for global stocks would make a lot of investors happy. Earnings growth propelled stocks higher in the first half of the year. Analysts expect earnings to grow 43% for global stocks this year. Old economy sectors – energy, steel manufacturers, and banks – outpaced the new economy stocks, which had previously benefited from the shift to remote work and increased time at home.
Since 1926, there were eighteen years in which stocks gained 12% or more in the first half of the year. In those eighteen years, returns averaged 8.6% for the remaining half of the year. Second half returns were positive in twelve of the eighteen years. While hardly a forecast, the market often does unexpected things.
As summer continues and trading volumes sag, volatility could pick up and a pullback from recent highs is possible. Any number of concerns could weigh on the market’s confidence. While the impact of the delta variant or a change in tone from the Fed seems most plausible, stock market corrections are rarely telegraphed ahead of time. It’s always a good idea to be prepared, emotionally and financially, for a selloff at any unexpected moment.
What It All Means
Since the March 23, 2020, bottom, the S&P 500 is up 96%, nearly doubling its value in less than 16 months. Excitement in so-called cryptocurrency and meme stocks – GameStop, AMC, and several others – has been an object of fascination and cocktail party fodder. The stock market recovery and gamification of stock trading raise concerns that current risk taking may be excessive.
There are reasons the market recovered so quickly – earnings growth, low interest rates, and consumer and government spending. Still, how you feel about the recent run-up of stocks and financial assets depends on your personality and worldview. Some feel validated by a hot market, convincing themselves the good times will carry on. Others view recent gains as too good to be true.
Regardless of your view, don’t hold your beliefs about the market too strongly. Humility is important for successful investing. Also, keep in mind some fundamental principles:
Avoid overreacting. Don’t make large changes to your portfolio based on your view of the short term. Markets can and often do behave in unexpected ways.
Have a healthy appreciation of the potential volatility of any one stock or investment. The risk of loss is high on ill-timed purchases. Sudden moves can occur over night, limiting your ability to exit at a predefined level.
A basket of stocks is less risky than one. But the risk is not necessarily eliminated in a basket of stocks. Shares of companies that do similar things, or have similar characteristics, often behave similarly.
If you are considering highly speculative investments, focus on the risk and manage the downside. Investing in cryptocurrency and meme stocks can be fun, but don’t let entertainment become too costly. Limit highly speculative investments to a predetermined amount.
As always, be wary of anything that sounds too good to be true. If someone offers high returns with little to no risk, be careful. Also, Reddit chats walk a fine line between social space for sharing investment thoughts and an arena for pump and dump schemes.
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