Reflationary Pause
The month of August saw a pause in some of the reflationary sectors that we have favored for most of the year. Most notably, the energy sector pulled back -1.92% in the month of August. Industrials posted a small gain of 1.14% in the month of August as well. One outlier was the financials sector, which posted gains of 5.12% for the month. Other sectors that did well were growth or momentum sectors, including technology which was up 3.55% and communication services, which includes names like Facebook, Alphabet (Google) and Netflix, posted gains of 3.89% in the quarter. One interesting divergence to point out was utilities posting returns of just shy of 4% on the quarter. With interest rates doing very little for the month of August, it's a bit unusual that both utilities and financials had strong quarters, being that they generally react inversely to each other. This will be something to monitor over the coming months.
Market Recap
Broadly speaking, markets had a good month in what was a tumultuous month from a political standpoint. Amidst the poorly planned US exit from Afghanistan and the disaster that ensued, markets were somewhat indifferent to headlines coming out of the Middle East. Below are broad index returns for US indices and also globally.
Source: Morningstar as of 8/31/21
Leading the way for the month was the technology and biotechnology heavy NASDAQ 100, as indicated by the Invesco QQQ ETF. Currently it's a fair fight between the S&P 500 and the NASDAQ 100. Investors should be reminded that nearly 25% of the S&P 500 is now made up of technology stocks. Including Communication Services, which includes many names included in the FANG acronym, these two sectors are more than 36% of the overall index. This begs the question, is the S&P 500 really a diversified index or is it becoming a concentrated bet on technology and communications services companies?
Below is a breakdown of the sectors. As you can see, many of our preferred exposures, including financials, energy and industrials, are leading the way. It wasn't until the past 3 months where technology and communication services caught up to the cyclical exposures we have been overweight all year. Another sector worth mentioning is real estate. Part of the rebound in real estate has been the idea that certain sectors, mainly office, retail and other commercial sectors, won't be hurt as bad as previously expected. Real estate also performs very well in inflationary environments, which we are still in the camp that inflation is going to be more persistent than expected by the Federal Reserve. We also expect increases in rental rates going into the 4th quarter, which will be very supportive for this sector.
Source: Morningstar as of 8/31/21
Lastly, we have included fixed income returns below. While rates were relatively benign for the month of August, interest rates, mainly on the longer end of the curve, had a large move when we had small bouts of market volatility in May, June and July. That being said, broad returns for fixed income are largely negative, save high yield bonds which are the only bonds that have posted positive returns for 2021. We don't expect to see much in the way of rates moving higher, or lower for that matter. As long as defaults remain near all time lows and monetary and fiscal policy are supportive, investment grade and high yield credit will likely be the best places to earn total return in the fixed income asset class. For portfolios that have meaningful allocations to bonds, this clearly has been a drag on the portfolio, where anywhere from 40% - 60% of the portfolio is earning 0% or negative returns.
Source: Morningstar as of 8/31/21
Outlook for 4th Quarter 2021
Barring any significant resurgence in any COVID variant, we are very positive on the outlook for the rest of the year. The return of students to in-person teaching should be a tailwind for labor dynamics. Increased activity on the leisure and entertainment industries should also help to provide tailwinds for the economy. Growth in GDP and inflation will likely continue to accelerate, which will be supportive of some of the more cyclical sectors that did so well in the first half of the year.
Should you have any questions or would like to schedule time to talk about your portfolio, feel free to schedule a meeting.
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