Amazingly, the year is already halfway over. It’s been full of events so far: a new President, battling COVID, vaccinating for COVID, Tom Brady winning another Super Bowl, meme “stonks,” genetically modified mosquitos (yikes!), and the gas pipeline hack and gas shortage. Through it all, the S&P 500 closed the first half of the year with a gain of 14.41%, according to Morningstar. Small-cap stocks did even better, as the Russell 2000 index is up about 17% so far. The international index (EAFE) is up close to 10%. The energy (oil and gas) sector was the big winner among US stocks, as the S&P Energy Sector was up 42%. Utilities were the laggard, only gaining about a percent. Utilities don’t like rising interest rates, which we got in the first half.
Bonds also tend to not like a rising interest rate environment, so the Barclays Aggregate Bond Index lost nearly 2%. Commodities, on the other hand, have enjoyed the rising interest rates, as rising rates may indicate economic growth and inflation. The Bloomberg Commodity index is up a bit more than 20% so far in 2021.
The big shift within the markets this year has been the movement from “work from home stocks” to “reopening” stocks. Investors are thinking that a slower spread of COVID will lead to more economic growth, so we’ve seen a resurgence in stocks of companies in the industrials, financials, and materials sectors.
So, what’s next? No one knows with certainty, of course, but our projections look promising. Raymond James has recently upped its price target on the S&P 500 to 4400, so we are growing more bullish. My indicators are showing that we could see considerably more strength than that. We’re stretched currently, but after some sideways movement for a while, or maybe a small pullback, I think the stock market can move higher.
What could slow those expectations down? Certainly, an aggressive Fed could do it, if it decides to taper bond purchases at a faster rate than expected. I don’t think it will raise interest rates this year, but that could be a negative if it does. Interestingly, in other rising rate environments, the stock market has actually moved higher over the next 12 months, not lower. So, rising rates don’t necessarily mean that the party for stocks is over.
Inflation fears, which often push interest rates higher, are also a concern. For sure, there are pockets of inflation that are producing eye-popping numbers. My feeling is that inflation will not get out of hand, and that it is mostly COVID-related. But it could create short-term hesitancy from buyers, which should cause prices to come back down eventually, staving off inflation. Bond prices are not predicting inflation as of now, although they were earlier in 2021.
There’s also some tax-hike risk, and I think we should all prepare for that. I like most of the infrastructure bill, as infrastructure spending is really more of an investment, which provides “dividends” of sorts in the future. I think we all benefit from improved roads and bridges, as it reduces wear and tear on our autos and on the trucks that transport our goods. Better internet infrastructure seems beneficial, too. While infrastructure might pay for itself in the long-run, taxes may have to go up in the short-run to pay for it. That could be a headwind to corporate earnings (and passed down in the form of lower stock returns), although it may actually add to the earnings of companies involved in infrastructure buildout (like steel, heavy equipment, or 5G internet).
All of this leads me to believe that the most likely scenario for the next few months is boring…stocks will likely move sideways, with occasional pops up and down, and some rotation among sectors beneath the surface. If I’m wrong, it will likely be to the upside, that stocks have a much higher move in front of them. If we get troubling headlines on the COVID, tax, or inflation fronts, there is a small risk of a correction. As for bonds, I’m recommending keeping quality high and maturity short. I think bonds will provide ballast in this environment, but not much return. Tax-free municipal bonds have been good performers, though, and with infrastructure spending and higher taxes in the news, I wouldn’t be surprised if that continues.
I also recommend keeping expectations realistic. There was a survey recently that suggested that the average US investor is expecting 17.5% average returns for stocks. Since the long-term historical average is somewhere closer to 10%, I think those who were polled are too optimistic. I hope we get 17.5%, but I’m not counting on it, and I’d be happy with 10%.