The second quarter ended with the DJIA, S&P500 and the NASDAQ all at, or near, all-time highs. That said, there was some renewed volatility created by inflation fears, a massive amount of sector rotation, housing price concerns and more.
The interest rate on the 10-Year U.S. Treasury bond had accelerated starting in January and peaked right at the beginning of the second quarter at about 1.74%. This quick move from less than 1% in January created inflation fears as prices both at the wholesale and consumer level rose. It was feared that if inflation spiked too quickly, the Fed would have to start tapering economic stimulus, which could threaten the recovery. Nothing pointed to inflation more than the price of lumber, which more than doubled in less than two months.
The question became whether the rise in inflation would be transitory or sustained over a longer period of time. We believe that inflation will not get out of hand and is a shorter term issue. Inflation was caused partly by companies having to rebuild inventories after the economy started to reopen. There was also a tremendous amount of demand at the same time inventories were low, and product production was curtailed by the pandemic.
Due to the fear of inflation, higher interest rates and the potential reduction in economic stimulus, the market paused in the first half of May. The NASDAQ had provided the market with leadership, but the concern about higher interest rates reaccelerated the move out of growth stocks into value. Suddenly, the more economically sensitive and cyclical stocks began to outperform growth and technology.
Couldn’t hold them down! The NASDAQ fully recovered from the rotation out of growth by mid-April and has since made new highs. The fact that both growth and value are now performing well is good for the market. Participation has broadened out instead of the market doing well only being carried by technology, which represents about 25% of the S&P500.
Another concern has been the price of housing and some have indicated they feared another housing bubble like 2007-2008. We believe it is much different this time. The previous housing crisis was fueled by easy money. Mortgages were given to anyone who could fog a mirror with little to no equity and for houses they could not even afford. This time, housing prices are simply up due to strong demand and low inventory. In March, for example, the number of existing homes for sale was the lowest since statistics have been kept. We do not see a housing bubble but instead, believe prices will level off for some period of time.
Now the market is concerned that interest rates are falling again. The fear is that this predicts the economy may slow or hit a rough patch ahead. We believe it is obvious that the economy will not continue to grow at the accelerated reopening pace, but the market as a leading indicator, knows this too.
The amount of debt being created by the Government in the form of stimulus and other spending is often a concern we hear. However, the amount of debt that is sustainable largely depends on the economic output. The amount of debt as a percentage of GDP (Gross Domestic Product) is actually lower now than it has been at other times. For example, $100,000 of debt is much different for a person making $30,000 a year versus someone making $200,000 a year. So, though the U.S debt level is concerning, as long as the economy continues to grow, it becomes less of an immediate issue.
Our ear is never far away from the railroad tracks, and there will continue to be some volatility ahead. However, due to corporate earnings growth, the amount of liquidity available to the market, and low historical interest rates, we believe the bull market is still intact and remain optimistic.