The resiliency of the U.S. equity markets continues to be impressive. In spite of elevated unemployment numbers, higher inflation, and the Delta variant spreading in many parts of the country, the S&P 500 Index of large U.S. companies continues to hit new highs:
Historically, stocks have produced flat to negative returns in the month of August. But the S&P went against the grain by posting a positive return of 3% (with dividends) despite several news events that threatened to upend the markets. One such event was the geopolitical risk posed by the rapid fall of Afghanistan to the Taliban. Another hit closer to home with Fed Chairman Powell signaling when the Fed might begin to end its economic stimulus, referred to as “tapering.”
During the economic crisis brought on by the pandemic last year, the Fed injected liquidity into the system by buying assets such as Treasuries and mortgage-backed bonds, a process known as quantitative easing. Now that the economy is well on the road to recovery, there is less need for the Fed to supply easy money. “Tapering” refers to the Fed reducing the amount of bonds it purchases every month. Powell indicated this could happen before the end of this year, with an official announcement possibly as early as the Fed’s September meeting.
Chairman Powell’s comments at the end of August included a separate, but perhaps more important, topic for the markets: the timing of when the Fed might begin to hike interest rates. The equity markets rallied after Powell indicated there was still “much room to cover” before the Fed would begin to raise rates.
When yields began to rise at the end of last year into 2021, there were fears of repeating the “taper tantrum” of 2013 when a sudden spike in Treasury yields caused a panic in the markets.
Interest rates tend to rise when inflation rises or in anticipation that the Fed might hike rates sooner than expected, both of which occurred early in the year. But the 10-year Treasury yield has come back down off its spring peak, settling around 1.3%. The Fed’s belief that the current rise in inflation is only temporary, coupled with reassuring words that rate hikes are off in the distance, helped to calm equity markets and push August into a strong close.
What changes did FSA make in the portfolios during the month with the upward bias in stocks? Fortunately, the strategies entered August with equity exposure already at their upper limits, so the portfolios participated in the month’s rally. Even the Income strategy managed a small gain, with some areas of the bond market performing better than others. When portfolios are “fully invested,” FSA will make tweaks as we did by shifting out of small-cap stocks in favor or large-caps and adding exposure to growth stocks (versus value stocks) where appropriate.
With the major U.S. stock indices at record highs in August, one might wonder what is left to push the markets higher. If equities make it over the hurdle of a historically weak September, the final months of the year, which are historically positive, could get a boost if the House of Representatives passes the $1 trillion infrastructure bill that the U.S. Senate approved in August. Such a passage is anticipated in October and could help sustain, if not bolster, the economic recovery.
As summer draws to a close, the year-end will be fast approaching. We encourage you to reach out to your advisor with any changes that might impact your financial goals.
Mary Ann Drucker
Assistant Portfolio Manager
Disclosures are available at https://fsainvest.com/disclosures/market-update/.