Stocks continued their upward trek during the quarter, with the major indices registering fresh all-time highs. Those gains are supported by an economy that has sprung open from the pandemic-related shutdown, as well as a continuation of the extraordinary monetary stimulus that got underway at the onset of the pandemic more than a year ago. People are enjoying the renewed opportunity to travel and get together with family and friends. Once the economy settles into its new equilibrium, our primary focus will be the potential for inflation. The Federal Reserve has noted the recent surge in prices, and they have shortened their lead time for tapering back on stimulus efforts.
Inflation emanates from two main areas, commodity prices and wages. Both areas are seeing pronounced upward pressure as the economy reopens. Bottlenecks in various supply chains have caused semiconductor chip shortages that impact the auto industry, rising lumber prices that make new home construction more expensive and surging oil prices that have pushed energy costs up more than 27 percent this year. The official unemployment rate has come down to 5.8 percent, a welcome improvement from the nearly 15 percent peak roughly a year ago. However, parts of the economy are now experiencing labor shortages, especially with entry-level positions. People are eager to travel and return to restaurants, causing businesses to compete for workers. Rising home values and attractive borrowing rates have motivated a flurry of cash-out refinancing that gives consumers spending money. In all, the reopening economic surge has led to the highest inflation numbers we have seen in roughly thirty years.
The Federal Reserve has taken note of the recent jump in prices. Commentary following their most recent meeting indicates the twelve-member Federal Open Market Committee (FOMC) believes the surge in inflation will be temporary. For now, the Fed plans to continue to support growth with extraordinarily low interest rates and open-market bond purchases of $120 billion per month to keep money flowing into the economy. While some FOMC members see a possibility of a rate hike this year, most expect the tapering of stimulus to be postponed until next year or even 2023. The commentary momentarily shook capital markets, as the updated timeline for trimming back on monetary stimulus is a bit shorter than previously anticipated. If higher inflation lingers, it may put pressure on the Fed to take their foot off the accelerator, and perhaps even tap the brakes.
Low interest rates continue to benefit borrowers, while making it difficult for investors to find decent yields for the bond portion of their portfolios. That means investors are currently relying on stocks to provide the lion’s share of progress for their portfolios. Stocks are doing a good job, yet we are continuously aware of the price volatility that accompanies stock market holdings. Stock prices can react quickly to changes in the economic outlook. Bonds remain our best source of relative safety, stability and liquidity for meeting near-term cash needs and buffering against the volatility of stock prices. We do not believe there is any reliable way to “time” the ups and downs of the stock market, so we encourage investors to maintain appropriate bond and cash holdings to wait out the slumps that inevitably occur. Given time, markets do recover. While stocks are performing well, it is a good time to evaluate the overall stock market participation to confirm the growth/safety balance is on target to meet the objectives for the portfolio. We always welcome your call if you would like to discuss this important topic.
Asset values are rising, and constraints imposed during the pandemic are being lifted. There is a surge of economic activity as businesses reopen and people are once again able to gather. It is a welcome moment that makes this summer exceptionally upbeat. We do expect this surge to settle down as we head into the latter part of the year, and hopefully supply-chain disruptions will be shored up. As the pandemic wanes and conditions stabilize, the Fed is expected to slow their monetary stimulus. Capital markets are likely to be sensitive to the timing and magnitude of the Fed’s actions and commentary. Investors can prepare ahead of time to make sure their portfolios have sufficient bonds and cash to ride out any short-term setbacks that may be down the road.
Enjoy a wonderful summer, and please contact us if you have any questions.