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3rd Quarter 2021 Market Review and Outlook

July 13, 2021 by Walker Higgins Associates

Quarterly Market Review and Outlook

Q2 2021 Market Re-Cap

The U.S. economy continued its march to full recovery and beyond during the 2nd Quarter.  Supported by a lack of negative news and improvements mostly across the board in labor, wage increases and continued low interest rates.

For the time being, we should be thankful that U.S. stock market continues to perform well.  So far in 2021, the broad U.S. market (S&P500 Index) is up double digits with small caps and value stocks leading the way.[i] [ii]

Unfortunately, the tough road for the bond market continued during the 2nd Quarter.  The broad U.S. bond market (as defined by the bond aggregate) is down this year.[iii]  Strategies like PIMCO Income and Guggenheim Macro Opportunities both have positive returns this year and they highlight the need to be “tactical” in this market.

Mark Twain supposedly once said, “history doesn’t repeat itself, it often rhymes.”[iv]  So far, 2021 looks remarkably like 2013 to us.  Stocks performed well and had amazingly little volatility in 2013, while bonds suffered as the fear of rising interest rates took hold.  If 2021 continues to play out as 2013 did, then we should expect continued solid returns in stocks and subdued returns in bonds, but elevated volatility on the horizon.

2021 Q3 Outlook & Beyond

Washington Regulatory & Political Update

We would strongly argue that while the Federal Government would like for us to think that they are the most influential driver of our economy and financial markets, they play second fiddle to corporate profits and earnings, consumer spending, and innovation.  Government regulation and policies generally move too slowly to have significant short-term impacts upon the economy and the financial markets—policy changes take time to filter through the system.

That does not mean, however, that government policies do not matter.  Albeit medium and long term, there are consequences for what the Federal Government does or does not do.  For those that are keeping track, in 2020, the Federal government spent $6.55 trillion while taking in only $3.42 trillion in revenue.[v]  The projected 2021 deficit is $3.67 trillion.[vi]

What is the impact?

First, inflation has dramatically increased.[vii]  Inflation is essentially too many dollars chasing after too few goods. Many items including home prices, building supplies, gasoline, food, and automobiles have risen substantially.  To be fair, all aspects of our current inflationary environment cannot solely be contributed to government spending.  COVID induced supply chain disruptions still exist.  Unemployment remains elevated versus pre-COVID data, which impacts manufacturing. The real question is whether the recent inflation we are experiencing is “transitory” (to use the Federal Reserves term) or whether it is longer lasting.

Second, eventually somebody must pay for all this spending.  In examining projected budgets of the U.S. government, you will notice that on page 42 of 72 of the most recent budget that 2022 tax revenues are estimated to increase by about $600 Billion from 2021.[viii]  A significant portion of this increase is derived from a proposed tax increase bill, The American Families Plan.[ix]  According to this proposed bill, tax revenues would increase by raising taxes on a variety of income sources.  Everything from capital gains, tax hikes for high earners, deferral of gains from like-kind exchanges, step-up in basis at death, etc. would be on the table (see page 56 of 72).[x]

Whether or not we have a tax increase is a political decision.  We believe a massive tax increase coming on the heels of an economy still recovering from recession is a major policy mistake. A razor thin margin in the Senate reduces the probability of massive policy changes anytime soon.  Further, we would argue that there is an increasingly narrow window to enact tax reform in the short-term as 2022 will offer mid-term elections for the entire House of Representatives and 34 Senators. We will see in the coming weeks and months how this plays out and what economic and market implications it all has.

Stock Market Thoughts

As we mentioned above, the stock market has been on a solid run since late 2020.  Since late October 2020, the S&P 500 has not experienced a 5% or greater short-term decline.[xi]  This is yet another similarity to 2013.  The good news is that there is not a lot on the immediate radar that would indicate that a stock market crash (i.e., at least a 20% decline) is eminent.  However, we would offer a reminder that from mid-2014 to mid-2016, volatility returned to financial markets and returns were subdued.[xii]

This is not to suggest that we are recommending that clients dramatically reduce their stock allocations. We would tend to welcome a short-term stock market decline in the 5% to 10% range to restore some value and view that as a buying opportunity.

Federal Reserve and Interest Rate Update

The Federal Reserve cut interest rates to near 0% amid the COVID pandemic to serve as support for the economy.  Once everyone realized that the world was not coming to an end, the question shifted to, when will the Federal Reserve begin interest rate hikes?

First, the Fed has been buying bonds, both U.S. government and corporate issues, to ensure that a market exists and the interest rates that those bonds pay is reasonable relative to market conditions.  There are no current plans for drastic changes to this program, but we would anticipate that an initial step would be to reduce the amount of bond purchasing as they try to normalize interest rates.

Another tool that the Federal Reserve uses to stimulate the economy or control inflation is to adjust borrowing costs by raising or lowering interest rates.  The Federal Reserve recently said it would wait until 2023 to begin increasing interest rates.

Summary

The good news is that the recovery from COVID is well in hand.  The development of the vaccines in record time and their widespread availability in the U.S. has dramatically reduced COVID related deaths and infections.[xiii]  Additionally, U.S. economic growth for the 2nd Quarter is projected to be 8.6% annualized.[xiv]  If economic growth continues through the second half of 2021 at the current pace, then the U.S. economy will grow at its fastest pace since 1984.[xv]

The alarming data is more medium to long term.  Again, we are not suggesting that it is time to panic—not at all.  We are largely optimistic about where the financial markets are headed over the next few weeks, months, and quarters. However, it is important to remain vigilant and acknowledge that it is likely at some point all this spending, perhaps necessary in the short-term, will have to be paid back and has longer term implications.

Finally, it should be noted that Jerome Powell’s, Chair of the Federal Reserve, term expires in February 2022.  Whether Powell is reupped or President Biden nominates an alternative, the next chair will have to navigate a narrow path of increased debt, potentially higher inflation and normalizing interest rates.  We hope and pray that they plot a prudent path.

As always, we recommend that clients focus on their own unique set of circumstances and goals.  Resist the emotional urge to make decisions based upon biased media reporting from either side of the political spectrum.  They do not have your best interests in mind.

Thank you again for your continued trust and confidence.

We hope that you and your family had a terrific July 4th holiday. We truly won the lottery by being able to live as free people in the greatest country in the history of the world!

 

[i] https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview

[ii] https://www.ytdreturn.com/nasdaq-100/

[iii] https://www.morningstar.com/etfs/arcx/agg/performance

[iv] https://quoteinvestigator.com/2014/01/12/history-rhymes/

[v] https://www.govinfo.gov/content/pkg/BUDGET-2022-BUD/pdf/BUDGET-2022-BUD.pdf

[vi] https://www.govinfo.gov/content/pkg/BUDGET-2022-BUD/pdf/BUDGET-2022-BUD.pdf

[vii] https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm

[viii] https://www.govinfo.gov/content/pkg/BUDGET-2022-BUD/pdf/BUDGET-2022-BUD.pdf

[ix] https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/28/fact-sheet-the-american-families-plan/

[x] https://www.govinfo.gov/content/pkg/BUDGET-2022-BUD/pdf/BUDGET-2022-BUD.pdf

[xi] https://finance.yahoo.com/chart/%5EGSPC

[xii] https://finance.yahoo.com/chart/%5EGSPC

[xiii] https://covid19.healthdata.org/united-states-of-america?view=social-distancing&tab=trend

[xiv] https://www.atlantafed.org/cqer/research/gdpnow.aspx

[xv] https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=US

 

Securities offered through First Heartland Capital, Inc., member FINRA/SIPC.

Advisory Services offered through First Heartland Consultants, Inc.

Walker, Higgins and Associates Wealth Management, LLC is independent of First Heartland Capital, Inc.

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350 East Saint John Street
Spartanburg, SC 29302

Copyright © 2022 Walker, Higgins & Associates Wealth Management, LLC, Spartanburg, SC – All rights reserved.
Rick Higgins and Adam Higgins are registered to offer Securities through FIRST HEARTLAND CAPITAL, INC. Member FINRA/SIPC.
Rick Higgins, Adam Higgins and Matt Smith are registered to offer Advisory Services through First Heartland Consultants, Inc.
Walker, Higgins & Associates Wealth Management, LLC is independent of First Heartland Capital, Inc. Click here for important additional information and disclosures.
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