The economic reopening is finally underway in earnest! Restaurants, movie theaters, hotels, airports, and malls are all busier than they've been in more than a year. The number of vaccinated individuals is reaching staggering levels and has led to a dramatic decline in infections, hospitalizations, and deaths.
All of this has led to far fewer restrictions on individuals and businesses (by the time you read this, all, or at least most, governmental restrictions in Dane County will have been lifted) and the results are awesome. But – yes, there had to be a “but,” didn’t there? – all this activity, combined with the unprecedented amounts of fiscal stimulus being pushed into the economy, could lead to trouble.
It reminds me of Pleasure Island in the Disney movie, Pinocchio. You may recall, Pinocchio is led to Pleasure Island to experience all the fun and mayhem a young boy could possibly want. But what he and his new friends didn't know was that a price had to be paid for their revelry. After their night of fun, they would all be turned into donkeys and sold into hard labor in the salt mines.
Could the fiscal high we are experiencing come with a similar price, one that takes the form of higher inflation, higher taxes, and higher interest rates? Are we staring down 1970s-style inflation, with the threat of early-1980s-like higher interest rates and recession on the horizon? Or will we enjoy a happy fate, like Pinocchio? Only time will tell, but for now, at least, we should enjoy the party responsibly, with one eye on the door if/when things get out of hand.
The month of May had its ups and downs, as the markets tried (and continue to try) to understand the re-opening of the economy and process a return of normalcy. Most indices finished in the black for the month, except those that were more growth- or tech-oriented. Equity indices were led by the international EAFE index, which gained 2.89%, and the DJIA, which gained 2.21%. The NASDAQ gave up 1.44%, while the Barclays US Aggregate Bond index gained 0.33%.
The shift from growth to value continued, as has been the case much of this year and could remain the case for the next year or more. All major indices we follow are still showing very nice returns YTD, with the lone exception being the Aggregate Bond index. With the amount of money floating around the economy, we expect the markets to continue to move higher by year-end.
As we've been noting for some time, volatility is here, too; economic data fluctuates daily, and expectations of what the Fed will or won't do is on investors' minds.
Economic growth is so strong here in the second quarter that estimates by some show GDP approaching 10% (annualized)! That's a huge number and it's a direct result of reduced restrictions around the country and consumers' appetites for just about everything. The problem is that demand is overwhelming supply in many sectors – think restaurants, hotels, rental cars, auto sales, and more. Semiconductor shortages are leading to an inability to produce everything from autos to cell phones, and are leading to price increases in many of those same products. Lack of workers (for a variety of reasons) is causing many service-sector employers to limit availability (fewer seats in restaurants, fewer hotel rooms or limited service at those fully open), causing waiting times and/or prices to increase.
Demand is not going anywhere soon, as there is too much money out there, but the good news is that supply levels should improve over time. Manufacturers are running full steam and shipping delays are much shorter than they were only a few weeks ago. Other issues related to employment will also improve over the next few months, as wages rise and added government benefits begin to subside. While there are some that feel higher inflation is here to stay, many do expect it to be transitory. Should that prove true, our ability to navigate what could become troubled waters will be vastly improved.
There has not been much change in what the Fed is saying publicly regarding the economy (strong and gaining strength), inflation (running above 2% target, but transitory), and interest rates (steady). It hasn't indicated a point at which it may taper its bond buying or raise interest rates, although some Fed members have acknowledged they will need to do so at some point.
Those concerned about higher inflation sticking around are looking for the Fed to act sooner rather than later. Those that expect inflation to be transitory do not expect the Fed to raise rates until late 2022, or even into 2023. The easy-money policies have certainly helped the economy regain its footing and then some, but if the Fed gets it wrong, it may really hamper its ability to rescue the economy in the next downturn, which could be caused by its own actions.
Our outlook has not changed: We believe that the forecast for the economy is very good. Unfortunately, like any beautiful, sunny day, a cloud or two can quickly cool things off. If those clouds turn into a thunderstorm and produce damaging winds, hail, or perhaps a tornado, we would have to seek cover and ride it out as best we can. We feel that the few clouds we're observing are just that – puffy white clouds – but we're keeping an eye on them to make sure they don't turn into something bigger.
How do we prepare for whatever may come? By being diversified, somewhat defensive-minded, and ready to act if danger appears imminent. From a market perspective, we continue to stress that a correction sometime over the next six to 12 months is likely and perhaps overdue. Getting rid of the froth (e.g., letting the storm pass) is a normal market condition and could be what the market needs to move substantially higher.
At this point, limiting your exposure to interest-sensitive growth stocks will lessen volatility. Utilizing a diverse toolbox of value stocks and other investments may help minimize damage in an inflationary and rising-rate environment, and should be considered to enhance portfolios and provide downside protection.
To discuss your portfolio or any other issue you may have, please email me or call our Wealth Management team at (608) 826-3570. We look forward to speaking with you.