The last 16 months will go down as one of the most volatile periods in investing history, but with markets back to all-time highs, it was also one of the most profitable for investors. As we wrap up one of the strongest performing first six months of a year, it’s a good time to review what happened to get us here and start thinking about the big questions that will dominate markets for the rest of 2021.
The pandemic and resulting stimulus efforts have created an economic environment that is far from normal. The traditional market dynamics of price discovery have been affected by the sheer amount of “free money” in the system. But as countries rollout vaccines, end lockdowns, and wind down stimulus programs, can we return to what we used to think of as normal? And what will that mean for markets?
This “normalization” is the question that is at the heart of all market concerns. It seems everything has an asterisk attached to it. You can’t look at any economic data without questioning how stimulus cheques and employment benefits have affected it. When looking at the rising price of goods and commodities, the idea that this is “transitory” seems to always be mentioned as a reason to ignore it. Everyone is looking for pure data that just doesn’t exist.
At no other time in history have we had the entire global economy shut down for months and then be turned back on. In a world of just-in-time inventories, broken supply chains are a major problem. It makes some sense that this has resulted in some dislocations that caused prices to spike. But will they really just go back to normal in a few months?
It is in this environment that central banks now need to determine when to scale back on their stimulus efforts. At the last FOMC meeting, we heard the beginnings of the dreaded “taper talk.” They now have dared to speak the word, which is prudent, although it may not be soon enough for them to act, get back ahead of the curve, and control for inflation. The positive for equities is that this discussion is now out in the open, yet markets are higher.
Envisioning the world beyond government and central bank stimulus efforts will be the story of the second half of this year. Many programs will begin to be taken off post Labour Day, and by Q3 earnings comparisons will be harder for companies to achieve. With a market close to being priced for perfection, this could make for a harder investing environment. It should be less of a market focused on the macro, and security selection will become very important.
Since the U.S. election last fall, equity markets have seen a dramatic shift in factor leadership. Gone are the days of only the large cap technology stocks dominating and everything else sitting on the sidelines. The reopening trade has led to a rapid move higher in bond yields and allowed long-forgotten sectors, such as energy, to take the lead. Cyclicals, including the banks, are back in favour, allowing for the S&P and TSX to outperform the American S&P 500 for the first time in many years. In a more challenging environment. do these trends reverse? Does the new defensive sector of technology resume leadership? These questions will all need to be addressed.
While large cap technology stocks, famously referred to as the FANGs, have underperformed this year, one area that has caught investors’ attention in their absence has been in meme stocks. Meme stocks are usually companies that would often be classified as junk and were heavily shorted. This created the perfect storm for an army of retail traders to team up to create some of the biggest short squeezes in history. Is this just another example of too much cash in the system, or are these signs of excess risk-taking that usually come near the peak of bull markets?
With so many unanswered questions it’s probably prudent for investors to be questioning what they should do next. Recent trends may result in a shift back to active management. Across fixed income and equities, for most of the last decade, investors have been content to just buy the benchmark and go about their lives. But as the world gets back to normal, it’s probably safe to assume there will be some bumps along the road. These bumps will result in volatility, and volatility can mean opportunity for active managers.
Summer markets are notorious for being difficult to trade because of thin volumes, so many take time away from their portfolios. But it’s also time to get ready for what is shaping up to be a more challenging second half of the year.
We entered 2021 coming off the shock of the pandemic and a contentious U.S. election, but the markets have gotten off to an impressive start. Has this been as good as it gets, with the difficult part before us? It’s too soon to tell but given how often the narrative has switched in the last year, it’s probably a great time to make sure you are positioned for another shift. The more things change, the more they stay the same.
— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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