Much of what we outlined in our Q1 2021 newsletter in terms of potential challenges to equity and fixed-income markets remains true today. Progress in reopening the domestic economy however trumped those challenges over the course of Q2. Equities soared and our models were very much along for the ride. Having deployed risk management measure due to dramatic spikes in interest rates early in the year we were able to capture gains, hit the reset button per se and redeploy idle cash this spring. This led to a reconfiguring of approximately 35% of the equity model just as market regained their footing and formed a new trend. And ultimately robust returns. Half way through the year we remain optimistic as vaccination rates in the U.S. approach 50% with similar figures across the developed world. Reopening should continue through the second half of the year fueling continued economic growth.
Potential headwinds remain focused on over-valued asset pricing and inflationary fears. First let’s look at asset pricing and domestic equities in particular. As technical analysts we don’t often take a fundamental view but in this case, it is worth noting that the P/E Ratio of the S&P 500 index is currently a 3x multiple of its historic mean. In and of itself that is not something to lose sleep over but certainly something to be conscious of. Simply put investors today are willing to pay 3 times as much for a dollar of a company’s earnings as they have been historically speaking. Another reason we base our strategy first and foremost on managing risk and monitoring underlying exposure on a daily basis. Whether this is a bubble remains to be seen but we feel confident looking ahead.
Turning to inflation, and equally as important central banks’ response to potential inflationary fears in the future, we feel spikes in Q2 were temporary and that a reversion to the Fed’s target rate of inflation is the most likely outcome. Wage growth, stimulus and a choked supply chain were seemingly the culprit in April and May and should normalize as reopening progresses and economies normalize. It appears any meaningful move to combat inflation by the Fed is by tapering quantitative easing in 2022 and nothing in terms of an interest rate hike until 2023.
Generally speaking, Q2 was relatively quiet for the Tactical Allocation Portfolio (TAP). The quarter saw just a handful of trades on the equity side as risk was muted while equities marched higher. The May inflation reading being the only meaningful bump in the road.
The fixed-income sleeve was reinvested just days into Q2 and has performed well as interest rates moved generally lower over the course of the last 3 months.
As pleased as we were with the results, we will never lose focus. Our strategy and models are based on a very strict set rules which dictate our decision-making process. As those who have worked with us long term will attest to. We are hopeful what we have outlined above in terms of reopening and its impact on future growth sustains the current trend but remain prepared should an unforeseen event change this market’s course.
Fraser, Dudley, Alex, Josh, Christie & Melanie
