State of the Markets
Positive momentum continued in the second quarter of 2021, resulting in very attractive returns for the first half of the year.
As of June 30, the global stock market (MSCI ACWI IMI) was up 7.2% for the quarter and 12.7% YTD. The U.S. stock market (Russell 3000) had positive performance of 8.2% in the quarter, bringing YTD returns to 15.1%. International developed markets (MSCI World ex USA IMI) rose 5.5% for the quarter, increasing YTD returns to 9.9%. Emerging markets (MSCI Emerging Markets IMI) returned 5.7% for the quarter, raising YTD returns to 8.8%. Publicly traded real estate (S&P Global REIT) continued its significant recovery with gains of 10.2% for the quarter and 17% for the first half of the year. The U.S. bond market (Bloomberg Barclays U.S. Aggregate Bond Index) was up 1.8% for the quarter, reducing the YTD loss to -1.6%.
The total returns for major asset classes are below.
Global stock markets seem to be pricing in a good future while we are still experiencing uncertainty and disruption. Uncertainty involves COVID variants, vaccine distribution, and effectiveness. Disruption includes supply chain issues, price spiking, and labor market imbalance.
The pandemic is not over. Cases are rising again, and even countries with significant vaccine adoption are experiencing spikes due to the delta variant. While cases have been relatively low in the U.S., there is no guarantee we won’t see another wave.
The vaccines are not perfect, but they are helping. Vaccinated people are significantly less likely to get infected. Even if they do, they are less likely to have significant illness, and therefore less likely to be hospitalized or spread the virus. The recent COVID cases are also concentrated in younger age groups, which generally have less severe reactions. We can see these trends in the chart below, which reflects the 7-day average of cases, hospitalizations, and deaths in the U.K. (where the delta variant seems to be widely spread). Cases are high and rising (measured on the left axis). Hospitalizations and deaths are low and not rising at the same pace (measured on the right axis). We hope this indicates that the virus will be manageable and less dangerous going forward.
In a prior Market Update, we referred to this recession as a “party that was running fine (until) the lights went off and the dancehall went dark.” The good news is the power has come back on, and the party has picked up where it left off, or at least it’s trying to.
From an economic perspective, things are thriving. Q1 2021 real GPD was a very positive 6.4%. Public company sales represented by S&P 500 (according to Yardeni Research) have recovered significantly, but more importantly, the remarkable resilience and adaptation of these companies has resulted in record earnings. Employment has continued to recover as well.
With all that, we are pushing the envelope on supply and demand. While supply and demand is always a wobbling balance behind the scenes, we don’t usually experience any significant consequences on the front end (which is a remarkable aspect of capitalism). However, in the last 18 months, the pandemic economy has created issues that are not easy to fix. We see this in chip manufacturing, shipping, commodity supplies, labor market imbalance, etc. While none of this is fun to watch and can be painful (especially if you’re looking to hire or buy a couch), it’s very likely to be temporary.
Rebalancing: Sell High, Buy Low
Rebalancing your portfolio keeps your allocation in line with your goals and creates opportunities to take advantage of swings in the markets. We often say rebalancing is a systematic way to sell high and buy low.
Rebalancing is driven by an asset class performing very well and rising above its allocation goal, or an asset class performing poorly and falling below its target allocation. The eventual reversion to mean, by both the best and worst performers, creates the potential value in rebalancing. At the highest level, this applies to the allocation between the growth (stocks) and stability (bonds) portions of the portfolio. Underneath the hood, it applies to all the assets classes within each category.
Rebalancing opportunities can occur based on specific client circumstances (cash coming in or out of your portfolio creates an opportunity to adjust allocations and keep them within the desired range), or significant moves in markets. The market decline in early 2020 created a significant opportunity to sell some bonds and buy stocks. If you managed to make a good, but difficult, decision to rebalance during the downturn, then your current allocation to stocks may be larger than preferred. This may create another opportunity to take some chips off the table, sell a portion of stocks, (which are not far off all-time highs and trading at high valuations), and put the proceeds back into bonds.
We are in recovery mode – economically, socially, and medically. There is a lot to celebrate, but also a lot of concerns.
Howard Marks is the founder and Chairman of Oaktree Capital Management. He is a well-respected manager and author. His quarterly memos are considered some of the best in the industry. A mantra he originally used in 2013 (another time when the markets seemed to be ahead of the economy) applies to today: Move forward, but with caution.
As always, thank you for your trust and confidence.