Year-to-date returns for the major stock indices and the current bond and money market yields
are as follows:
|Dow Jones Industrial Average||12.73%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
|Fidelity Government Cash Reserves Money Market Fund||0.01%|
Happy 4th of July! As we again celebrate the birth of our nation, we would like to reflect on the strong first half of 2021 in the equity markets. Any way you slice it, the equity markets are doing well as every sector of the S&P 500 is positive for the year. If you are a holder of equities, you are generally pleased; every equity style, from value to growth to foreign, is performing. The vaccines are working, and the virus is becoming less of an issue for equity markets with each passing day. The American economy (as measured by GDP) is on pace for its best year-over-year growth since 1984, and pre-tax corporate profits are back to all-time highs. American consumers and corporations are flush with cash, and the pent-up demand is unwinding into the economy. Combine all of this with an asset-friendly Federal Reserve Bank committed to low interest rates, and you have higher stock prices and an economy ready to roar.
As we often communicate, looking backward is always easy, evaluating the present can be challenging, and prognosticating the future is even more difficult. As investors, we live in unusual times. We have had a litany of unprecedented and rare events: from shutting down the economy, to enormous stimulus packages, to unemployment rising from 3% to 14% in weeks, to the Fed increasing the money supply by over 25%, to delivering an effective vaccine in less than one year. Moreover, equity markets declined by 34% from February to March 2020, then rallied back to all-time highs by November. There is no doubt, 2020 was a wild ride in the markets for many, but long-term investors came out relatively unscathed with higher portfolio values. As advisors, we know among our responsibilities is to study and reflect on history, take the emotion out of investing, and champion the principles of long-term investing.
The markets are doing well now, but where do we go from here? Again, looking into the future is always difficult and requires a degree of humility. Despite rising stock prices, higher inflation, and excesses growing seemingly everywhere, there is still no attractive alternative to equities. The markets always need and look for reasons to sell off, and though we may be due for a decline, we remain optimistic for now. We maintain our bias toward value investing, and we generally refuse to chase high valuation stocks.
Regarding the bond market, we believe the prices are high, and the opportunity costs are still too great. We could rail on the pros and cons of the bond market being subsidized by the government, but that is not for this letter. In the real world, we have money to allocate.
In essence, a bond is a loan. You loan money to the government or a company, and they pay you interest. When the loan comes due, you are paid back your principal. In most cases, there is minimal risk to the principal. So, what’s the problem? Too little interest and rising inflation, for starters. As we have written recently, inflation has moved to the front of the most recent concerns for the overall markets. Inflation, as measured by the consumer price index, topped 5% in its most recent report. The cost of your goods and services has increased, and your purchasing power has eroded; which brings to light, what is a real rate of return? In short, a real rate of return measures your purchasing power; your total return minus inflation, a hill we all have to climb. If we park cash in money markets at 0% and inflation continues at 5%, purchasing power declines by 5%. Further, buy a 10-year Treasury yielding 1.5%, then subtract out 5% for inflation, and now your purchasing power is bleeding at a 3.5% annual clip.
We could go on and on, but the point is the same: owning cash or bonds is a problem that has only gotten worse. The predicament right now is whether excessive inflation will be short-term (transitory), and can the Fed successfully turn off the flood of cash through reduced asset purchasing and higher interest rates? If you follow the financial media, the word “transitory” is being used regularly in an attempt to explain away the fear of runaway inflation. This is a longer conversation, but we believe and hope that much of the excess inflation is ultimately temporary. More than ever, we long for the day to be excited to find attractive opportunities to buy bonds.
We thank you for your continued confidence in LYNCH & Associates. As always, we welcome you to schedule an appointment to review your financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Parts II & III of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics is available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or jfarless@LNAonline.com.
Office: 10644 Newburgh Road, Newburgh, IN 47630