On the night of February 13, 1814, as Francis Scott Key witnessed the battle that would inspire him to write the words that became our national anthem, the outcome was far from certain. It must have been an ominous sight—the full fury of the mighty British navy raining down upon Fort McHenry and this upstart nation. Only in the clear vision of daylight, when Key saw the American flag still flying, did it become obvious that America had prevailed and would eventually press the British into ending the War of 1812.
The U.S. (and indeed the world) has been through a type of war with the coronavirus. In the first half of 2020, no one knew what the ultimate outcome might be. It was a time of uncertainty and fear, with thoughts of a very dire and dystopian future in the minds of many. And now, a year removed from that time, we are facing a very different perspective. With the benefit of effective vaccines and a better understanding of the virus, the course of the pandemic is clearly in retreat, and the mood in most parts of the world is cautious optimism.
In the U.S., the mood seems to border on downright giddiness. I made a trip to Colorado recently, and both legs of the flight were completely full. The highways are crowded, the tourist towns are packed, and you have to plan early if you want to eat at a popular restaurant or attend an event.
As further evidence, look at the stock market. How else to explain why stocks have rallied over 40% during the past year, punctuated by the meteoric rise of bitcoin and the so-called meme stocks (discussed in last month’s update)?
Stocks in the U.S have risen for five quarters in a row, pushing them to all-time highs as the economy continues to recover from the sharp recession of last year. For the most part, it has been a party to which everyone was invited, as large companies and smaller companies and foreign companies have all participated to varying degrees. And all eleven sectors within the U.S market are positive for the year, led by energy, with a whopping return of over 40%, and trailed considerably by utilities, up only 1%. The technology-dominated growth faction of the market, which took a back seat to energy and industrial companies in the first quarter, reasserted itself in the second quarter. At this point, both growth and value stocks are up by double-digits.
Bonds, for their part, improved from their lackluster showing in the first quarter as both high quality and high yield bonds made moderate gains of around 2%.
The table below shows the year-to-date performance of several widely followed stock and bond indices:
Thoughts on the Second Half
Historically speaking, whenever the stock market has a strong first half of the year, it typically has a positive second half, even if the returns may be more subdued. The one notable exception was 1987 which many of you may remember as the year of the stock market crash when stocks fell over 20% in one day. So, while we can take some comfort with that historical tendency, we can’t be complacent.
There are reasons for investors to feel bullish in the second half of the year, depending on a number of factors:
- Covid-19 outbreaks continue to shrink (and no new variants take hold).
- Congress passes some type of infrastructure bill.
- Any rise in inflation becomes only transitory (lasting for less than a year).
Technically speaking, conditions remain quite positive. Most areas in the stock market are in uptrends. Even bonds have made a recent turn upward. If we wanted to quibble, we could note that momentum has slowed noticeably in many areas, with the exception of technology, which is making an effort to re-establish its leadership.
The common belief among many investors had been that the continuing global recovery would favor industrial and basic materials companies, as well as any areas of the market that stood to benefit from the reopening of the economy (travel stocks, leisure, etc.). In addition, inflation was expected to bubble up, which would also favor commodities. Rising inflation would also push up interest rates, which would be bad for bonds and good for banks. Well, as we finished June, we saw almost the exact opposite, as interest rates came down and growth stocks re-asserted themselves. This back-and-forth action has kept the Investment Team on its toes.
In terms of how these ebbs and flows are affecting your portfolios, most remain at or near their full allotment to equities. Currently, we have a slight tilt toward value stocks (financials, energy, industrials, basic materials); however, we have been making some recent trades that will make the portfolios more balanced between growth and value. Most portfolios have some international exposure (with only a modest boost to performance), as well as some modest exposure to small-cap stocks. This allocation should serve us well as we enter the second half of the year.
It has been refreshing to see life getting back to normal. I am always amazed at humankind’s ability to adapt and create and solve problems. The world has faced pandemics before, as well as global wars and depressions, but we have always persevered.
Another famous quote comes to mind: “It is always darkest before the dawn.” Good words to remember when difficult times strike us again (as they surely will).
Keep in mind that because we manage clients’ portfolios individually, the holdings in your particular accounts may differ somewhat from the averages.
Income (Strategy 1)
Interestingly, we made no trades in this strategy during the second quarter. The mix of high yield and multi-sector bond funds has managed to deliver positive returns, even though it has been a relatively difficult first half of the year for the bond market in general. This strategy retains its mix of roughly 50% in high yield bonds and 40% in various higher quality bond funds, with less than 5% in money market funds.
Income & Growth (Strategy 2)
Trading was light for the second quarter in this conservative strategy. We sold the convertible fund and the merger arbitrage fund and increased our allocation to the foreign fund. As we moved into July, these portfolios held 45% in equities and 45% in bonds and roughly 10% in money markets.
Conservative Growth (Strategy 3)
These portfolios continued to climb in the second quarter, helped along by rising stock and bond markets. During the quarter, we reduced the small-cap allocation and added two value funds (focusing on financial, energy, and industrial sectors of the market), but the results so far have been mixed. At quarter’s end, these portfolios held 65% to 75% in equities, 20% to 30% in bond funds, and less than 5% in money markets.
Core Equity (Strategy 4)
This all-equity strategy made further progress in the second quarter, helped along by our stable of so-called core funds, even as our international funds and our sector funds struggled to keep up. We reduced the small-cap fund, while bumping up our allocation to value funds. This included a recent purchase of an energy fund (specifically, a fund that invests in master limited partnerships). At quarter’s end, the portfolios held 95% in equities and less than 5% in money markets.
Tactical Growth (Strategy 5)
With the exception of a modest stumble in June, Tactical Growth accounts posted a solid quarter of returns. Coming into June, these portfolios were leaning into small-cap and value funds, which pulled back in June as large-cap and growth stocks performed well. As of July 1, these portfolios hold 70% to 80% in U.S. equities, 5% to 10% in foreign funds, 5% to 15% in commodities, and 5% to 10% in money markets.
Sector Rotation (Strategy 6)
Similar to Tactical Growth accounts, this aggressive strategy stumbled in June, as it had leaned more heavily into value areas of the market, which pulled back last month. The gold fund, in particular, fell sharply in June. In spite of this recent hiccup, this strategy remains one of our top-performing strategies for the year. After the July rotation, the strategy holds more of a balance between growth and value sectors, including financial, real estate, telecommunications, health care, technology, and internet funds.
Please remember to inform your advisor of any changes in your life that could affect your investment objective and how we manage your money.
Ronald Rough, CFA
Chief Investment Officer
Disclosures are available at https://fsainvest.com/disclosures/market-update/.