We’re halfway through the year already, and in some ways the second half of 2021 is poised to be dramatically different than the first. That’s because the “return to normal” that began at the start of this year is now well underway and will continue to expand in the next six months. Most mask-wearing mandates have already been lifted and most Covid-19 restrictions have been greatly relaxed. Socially, things should keep getting better, but what about financially? Will the second half of 2021 be better, about the same, or worse for your investments than the first half?
Naturally, no one knows for sure, but some recent developments might help give us an answer. Before I get into that, let’s talk briefly about where the economy and financial markets have been so far this year, and what it’s meant for income-based investors.
Even before Covid-19 infection numbers began dropping with the help of the three vaccines, the US economy came into 2021 going strong. To some extent, the economy has been in steady recovery mode ever since it first got sucker-punched by the pandemic in the second quarter of last year. That’s when the U.S. GDP shrank by a historic 31.4%. However, that was followed in the third quarter by an also-historic rebound of 33.4% growth. Growth continued at a strong 4.3% in the fourth quarter and an even stronger 6.4%in the first quarter of 2021.*
Shift to Overdrive
Like the economy overall, the stock market has been in recovery mode ever since feeling the initial impact of the coronavirus, although its rebound has been much more dramatic. After investor panic caused the market to fall by about 40% last winter, it came roaring back. In fact, two out of the three major market indexes had already hit new peak highs again by late summer. Naturally, a lot of that had to do with the historic relief measures approved by Congress and the Fed, since Wall Street has been more focused on artificial stimulus than on economic fundamentals for over a decade now. With yet another relief package in the works heading into this year, the stock market shifted into overdrive and rose steadily from January to early May, with all three major indexes hitting multiple new peaks.
At the same time, long-term interest rates also rose steadily in the first quarter. The yield on the 10-Year Treasury rate jumped from 0.93% to 1.74% between New Years and late-March.** Rates have leveled off and even dropped some since, with the 10-Year ending June at 1.48%. However, that big jump of more than 50% did create some challenges for income investors due to the inverse relationship between interest rates and bond values. The good news is that the soaring stock market and other factors also created conditions and opportunities for portfolio managers to help minimize those challenges. In fact, even our most conservative clients saw their portfolio values increase over the first half of the year despite the interest rate headwind. Those with a higher risk tolerance saw even greater increases thanks to strong performing value stocks, BDCs, ETFs, and other higher-risk income strategies.
So, while we can be reasonably sure the second half of the year will be better from a social standpoint, what about economically and in terms of the markets? Well, as I’m sure you know, after making that steady climb from January to May, the hot stock market suddenly cooled off a bit and volatility returned. That was mainly blamed on fears about inflation, and those fears have continued to some degree. June saw quite a bit of volatility, in fact. The Dow Jones Industrial Average sank below 34,000 for the first time since April,*** and ended June slightly down for the month.
Despite these recent bouts of nervousness, I don’t believe inflation fears will have a major impact on the markets in the second half of the year. As I noted in last month’s newsletter, I think the inflation spike we’re seeing now is transitory and caused mainly by pent-up consumer demand combined with some supply chain disruptions. As life continues returning to normal, that demand will outpace the availability of many goods and services, creating inflation. Once consumers get that pent-up urge to spend out of their systems, I believe prices will stabilize again sometime in 2022.
A ‘Good’ Picture
Also, remember that long-term interest rates have remained stable since that early year spike, and I believe that trend will continue. In addition, the Fed has renewed its commitment to keeping short-term rates near zero at least through the end of 2022. All these factors should—I believe—help minimize the risk of another major market pullback. At the same time, I think it’s likely the market growth we do see from now through December will be more gradual and less dramatic than it was in the second half of last year or the first half of this year. For the most part, Wall Street has probably priced most of this year’s earnings into the market already, and now it’s time for corporations to catch up. In short, I believe the economic picture will continue to be good for investors overall in the second half of the year, but not dramatically “better” like the social picture.
Of course, in the Age of Economic Uncertainty, anything is possible. There is a chance the economic recovery could strengthen beyond expectations and keep pushing Wall Street to lofty new heights. On the other hand, if second quarter earnings disappoint, if inflation turns out to be permanent, if long-term interest rates start climbing again, or if a vaccine-resistant Covid-19 variant emerges… Any one of these factors could quickly undercut the recovery and make the outlook for the second half of 2021 worse.
The bottom line is that, if the coronavirus has taught us anything, it’s the importance of having a financial strategy that expects the unexpected and is flexible enough to adapt to sudden changes. I don’t need to tell you that the strategy I’ve just described is called investing for income!
*Bureau of Economic Analysis, BEA.gov
**YCharts.com ***“Dow Falls More than 500 Points,” CNBC, June 17, 2021