Something to Think About...

Through traffic, keep left: Inflation was top of mind for most investors in the second quarter. Headline CPI jumped 5% on an annual basis in May, the largest increase in several years. While the number may appear quite high, it is important to recall the context of depressed prices from a year ago. Disrupted supply chains and strong consumer demand have been key drivers of higher prices in recent months. Volatile price segments, such as commodities have also been a factor, but are unlikely to persist over the long term, as high prices historically tend to eventually stifle demand. Core inflation also rose but is within the trend witnessed over the past decade. The Federal Reserve has communicated that the spike in inflation is expected to be transitory as we progress further into the economic recovery. For now, we agree with the Fed.

That bridge isn't going to fix itself: Infrastructure is a priority for the Biden Administration, and markets seemed to applaud a bipartisan agreement on a $1.2 trillion infrastructure package. While Wall Street would likely welcome the additional fiscal support for the economy, there are countervailing concerns among many investors around proposed increases in tax rates on income, capital gains, and corporate profits. Historically, both stocks and bonds have underperformed in the year following a tax hike.

Not so fast: Growth stocks rebounded significantly in the second quarter, outpacing value stocks: The Russell 3000 Growth Index outpaced the Russell 3000 Value Index by over 6% during the quarter. Traditional value sectors such as energy, materials, and financials cooled off after valuations surged and as bond yields moved lower. Alternatively, technology stocks that were adversely impacted by higher rates in the first quarter, recovered meaningfully as investors preferred growth companies and yields on bonds retreated for the quarter.

Data are as of 6/30/21 and all sources are Morningstar.

Present Positioning... 

Riding the recovery: We remain optimistic on the economy and risk assets as we enter the third quarter. Monetary policy remains supportive, consumer balance sheets are healthy, and corporate profits continue to exceed expectations. Additionally, improvements in the labor market, supply chains, and global vaccination rates are likely positive catalysts going forward. Inflation, valuations, and tax policy are potential headwinds; however, we believe the positives outweigh the negatives. Within global equities, we are overweight to mid/small caps and emerging markets, which may all do well as global growth accelerates.

Importance of bonds: Despite our optimism, diversification is a hallmark of our portfolios, and as always bonds have a meaningful role to play in portfolio construction. Here, our positioning emphasizes an overweight to U.S. Treasury Inflation-Protected Securities (TIPS) and to short-duration instruments within traditional fixed income. Both allocations have been positive contributors to relative performance year-to-date. And while yields are low, it is worth remembering that traditional fixed income remains the only true hedge to systemic drawdowns.

Once more on growth and value: As we head into the second half of the year, we are maintaining our small tilt to value equities. The strength and durability of the economic expansion could determine which style wins out over the long term, with value stocks potentially expected to out perform if the pace of the recovery remains strong and growth stocks potentially expected to lead when in a more muted economic environment.

Data are as of 6/30/21 and all sources are Morningstar.

Thank You
As always, a sincere thank you for reading. If you have any questions or feedback, please reach out to your Santander Investment Services Financial Consultant.