The good times continue to roll for investors. Stocks, bonds, and commodities saw widespread gains this quarter. The S&P 500 has seen 34 new all time highs since the start of the year and the market is up 92% from its March 2020 lows. The explanation for these stats is simple. The US economy is seeing an economic recovery unlike anything that we have seen before. The US consumer is the catalyst for the post COVID global economic recovery. After a year of built up savings, pent up demand, and $6 trillion in stimulus from the federal government, it is easy to see why we are experiencing the highest growth rates in generations.

For the second consecutive quarter, we had a leadership change in the market. In the first quarter, value stocks and smaller companies surged higher. This quarter growth stocks and larger companies lead the market higher. The shift between investment styles and market sizes has been constructive. When one style or market cap group has performed well for a period, they usually experienced a slight sell-off or pause, preventing it from getting too ahead of itself. This rotation has been helpful to sustain this bull market.

The sectors that have performed well in the quarter were real estate, technology, and energy. Real Estate (+12.26%) and energy (+9.85%) sectors benefit from the reopening trade. As people return to the office, traveling, and buying homes, it has lifted real estate higher. Energy prices likewise have caught a bid because of improvement in the global economy. A significant inventory reduction due to a cold winter and low prices last year curtailed new drilling activity have helped prices rebound. Technology stocks rallied back 11.18% in the quarter.

Investment Strategy

Our strategy remains the same as it has been the last two quarters. We remain overweight stocks and underweight bonds and cash. This strategy has served us well in the first half of the year. We plan to keep this approach in place for the time being. Our portfolios remain diversified and we have been careful not to overweight any specific style like value or growth.

Outlook

Inflation is the hot topic of the moment. It is the first time we have seen above average inflation in over a decade. Data this quarter showed prices rose about 3.8% from the prior year. The critical question is what will inflation look like moving forward. The consensus from Wall Street is we are seeing "transitory" inflation or a period of temporarily high inflation driven by the surge in economic growth. Inflation should return to around 2% next year. If this base case plays out, it is a positive signal for stocks because stocks perform well in lower inflation environments.

On the other hand, if this is the beginning of prolonged price increases, it could mark the change in investment conditions where low inflation has been in place for decades. We fall in line with the consensus that the surge in inflation will slow down in 2022 and beyond. High prices are the best solution to high prices. People will slow down purchases, new supply will come online, and alternative solutions will present themselves. If we are wrong, then interest rates will rise, and easy money policy will end.

Inflation and monetary policy are deeply related. One of the jobs for central banks like the Federal Reserve (Fed) is to keep inflation in check while maintaining economic growth. The Fed has indicated they intend to maintain their easy money stance for the foreseeable future. However, this quarter in response to record economic growth and the increase in inflation, there were signs the Fed could start to unwind their easy money policies a little sooner than the market expects. The market mispricing of the Fed's policy intentions is one the most significant risk factors in the next year. The Fed learned many lessons during the 2013 Taper Tantrum episode and we anticipate they will communicate clearly to the market to avoid a repeat of this.

We see the American consumer as a global economy driver for the remainder of this year. Saving rates continue to be high, personal income is increasing, job opportunities are robust, and households' net worth are at record levels. These are all reasons why the consumer will remain confident in the near term. The housing market has been on fire lately, mainly driven in part by the factors listed above. Continued strength in the housing market is another reason we are optimistic about the economy and the market. We do not expect prices to grow at the current pace because that is unsustainable. What the price surge since 2020 has shown us is we need more housing supply. The demand is unlikely to go away. It will just be delayed. When the housing market is strong and growing, the entire US economy is going to benefit. Homebuilding creates jobs for construction but also has a significant impact on many other areas of the economy. If you buy a new house you have to fill that house with new stuff!

What does this mean for your investments? We remain optimistic that stocks will perform well. Your expectations may need to be muted somewhat as the strong performance over the past 12 months is unlikely to be repeated. Another friendly reminder that it is normal for markets to see 5% or even 10% corrections in a bull market each year. The last time we saw a 5% or greater sell off was in November 2020. History does point towards a good second half of the year. In years when the S&P 500 has recorded a 12.5% first half performance or better, the second half has averaged about a 9% return. This has exceeded the average second half performance of 5% quite nicely. Second years of bull markets tend to be strong, but they see more choppiness than average market years. The average return for the second year of a bull market is over 12%. However, pullbacks have happened routinely in a range of 5% to 16% during these years.

Market valuations remain elevated but are more attractive on a valuation basis than early this year. The forward P/E for the S&P 500 is 21.53 and it closed 2020 at 22.3x. Earnings expectations have seen a meaningful increase this year of close to 20%. As we stated last quarter, if corporate earnings continue to meet expectations, stocks will continue to see a positive performance.

Andrew Comstock, CFAPrincipal - Wealth Advisor — *Andrew Comstock, CFA*
*Principal - Wealth Advisor*

US Market Viewpoints Q2 2021