Investments returns were solid across all asset classes in the second quarter, as economic growth continued to rebound from last year’s pandemic. U.S. stocks, international stocks, alternative investments, and bonds all generated positive returns.
U.S. large-cap stocks led quarterly equity returns, generating 8.6% as the S&P 500 reached new record highs. Mid-cap and small-cap stock returns added 3.6% and 4.5%, respectively, to their impressive year-to-date returns of 17.6% and 23.6%.
As vaccinations increased and active cases of COVID-19 declined, governments and businesses eased many of the restrictions put in place during the beginning of the pandemic.
A full economic reopening, coupled with pent-up demand and trillions of dollars in stimulus checks should drive favorable increases in GDP in the near term. However, there is the fear that this will also contribute to higher inflation. The market reacted negatively to inflation fears several times this quarter as inflation indicators grew. Fed policy makers revised their expectations for interest rate hikes, forecasting increases sooner than previously anticipated. The market quickly recovered from these bouts of volatility, but inflation continues to be a hotly debated concern for investors.
While returns of “value” stocks cooled this quarter, value has still managed to outperform the market year-to-date. This is driven by strong returns in energy and financials, two sectors with a high concentration of value stocks. Additionally, value stocks are still trading at attractive levels relative to growth stocks, which bodes well for the prospective returns of value stocks compared to growth.
International and emerging market stocks generated returns of about 5% for the quarter, not far off from U.S. stock returns. The spread of new coronavirus mutations in some countries shows that economic risks are still present from the pandemic and could impact stocks markets, especially in nations where vaccine availability is limited.
Aggregate bond market returns were a respectable 1.8% for the quarter, recouping some losses experienced during the first quarter. Despite signs of increasing inflation, the U.S. 10-Year Treasury yielded about 1.45% at the end of the quarter, down from 1.7% at the end of the first quarter, yet still higher than the 0.9% yield at the beginning of the year. With interest rates at historically low levels, expected returns for bonds are muted.
Alternative investments have had a much-needed resurgence so far this year. While it is too early to declare the start of a bullish cycle for alternative investments, we believe they remain an attractive source of unique returns. Their ability to diversify traditional stock and bond portfolios can help reduce the risk of the stock market and bring returns greater than the bond market.
While stock market returns have led the way over alternatives and bonds in the first half of the year, this has pushed already-elevated stock valuations to even higher levels. International stocks and factors such as value and low volatility appear relatively undervalued compared to U.S. large-cap stocks. Maintaining a diversified strategy will be more important than ever in the years to come.
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