Second Quarter Newsletter
Responsible Guidance: Second Quarter 2021 Newsletter, July 2021
Inflation, it is not the same for everyone...
During the second quarter, you may have noticed stories about inflation picking up in the media. If you follow financial markets, you may have witnessed Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE) data points increasing. As stories and data information circulate, you may be wondering how inflation will impact you.
We think, just like everyone's financial picture is different, the financial impacts of inflation are different to each person. If you own an electric car, you may not care about rising gas prices. Vegetarians are less concerned about increasing beef prices. If you and your dependents are finished with schooling, the rising cost of education may not be a concern.
When we work with clients on their financial plan, we can target specific costs that they may be sensitive to and add customized target inflation numbers for those items. For instance, typically we have higher inflation numbers for health care, health insurance and education in our planning process.
If you are unsure about how changes in the prices of goods and services may impact you, reach out to us to help plan for these types of possible changes. This will help you have a solid understanding of how inflation may specifically impact you and Your Personal EconomySM.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. The index was up 7.16% in the second quarter, as equity performance continued to move in a positive direction. Year-to-date the index is up 12.75%. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies. It was positive in the second quarter, up 0.98%, but remains down on the year at negative 4.75%. Investors clearly have been shifting resources toward risk assets over the previous few quarters and have had less demand for bonds.
Though inflation remains the hot topic in the media and in financial industry online conferences and events, most individuals, as well as the Federal Reserve (Fed) and their policy actions, seem to show little concern of inflation being a threat. Economies are improving as they re-open, consumers are spending with more confidence and jobs are coming back.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the first quarter of 2021 that real Gross Domestic Product (GDP) increased 6.4%, following the 4.3% growth reported for the fourth quarter of 2020.
The BEA regularly releases a note with GDP data. The note can be found on their website at www.bea.gov.
“The increase in first quarter GDP reflected the continued economic recovery, reopening of establishments, and continued government response related to the COVID-19 pandemic. In the first quarter, government assistance payments, such as direct economic impact payments, expanded unemployment benefits, and Paycheck Protection Program loans, were distributed to households and businesses through the Coronavirus Response and Relief Supplemental Appropriations Act and the American Rescue Plan Act. The full economic effects of the COVID-19 pandemic cannot be quantified in the GDP estimate for the first quarter of 2021 because the impacts are generally embedded in source data and cannot be separately identified. For more information, see the Technical Note and Federal Recovery Program and BEA Statistics."
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The May LEI, released on June 17th, improved to 114.5 (2016 = 100), following increased readings in April and May.
“After another large improvement in May, the U.S. LEI now stands above its previous peak reached in January 2020 (112.0), suggesting that strong economic growth will continue in the near term,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Strengths among the leading indicators were widespread, with initial claims for unemployment insurance making the largest positive contribution to the index; housing permits made this month’s only negative contribution. The Conference Board now forecasts real GDP growth in Q2 could reach 9 percent (annualized), with year-over-year economic growth reaching 6.6 percent for 2021.”
We think the following chart is an important tool to help potentially signal changing economic environments, such as recessions. The blue line represents the LEI, dating back to the year 2000. Since then, we have had two official recessions, which are identified by the shaded gray areas. A recession is typically defined as two consecutive quarters of negative economic growth. Using the last two recessions as a gauge, we believe that the chart suggests that there was significant erosion in the LEI (blue line moved lower) prior to the economy going into recession. Of course, in 2020, the shutting down of economies to help slow the spread of the virus lead to violent changes in economic numbers. Though we did not have 2 quarters of negative growth, we think it is safe to say the U.S. economic environment experienced challenges in 2020. There was a quick rebound, and many signals have turned positive, but challenges remain in 2021.
The full release from the Conference Board can be found at:
According to the Bureau of Labor Statistics (BLS), the U.S. gained 850,000 jobs for the month of June, and the unemployment rate moved lower to 5.9%. BLS suggests that job growth was notable in leisure and hospitality, public and private education, professional and business services, retail trade and other services.
The Conference Board Consumer Confidence Index® increased in June to 127.3 (1985 = 100).
“Consumer confidence increased in June and is currently at its highest level since the onset of the pandemic’s first surge in March 2020,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “Consumers’ assessment of current conditions improved again, suggesting economic growth has strengthened further in Q2. Consumers’ short-term optimism rebounded, buoyed by expectations that business conditions and their own financial prospects will continue improving in the months ahead. While short-term inflation expectations increased, this had little impact on consumers’ confidence or purchasing intentions. In fact, the proportion of consumers planning to purchase homes, automobiles, and major appliances all rose—a sign that consumer spending will continue to support economic growth in the short-term. Vacation intentions also rose, reflecting a continued increase in spending on services.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was up 8.55% in the second quarter, driving year-to-date (YTD) performance to 15.25%. For technical analysts and trend followers, the index remains above its 200-day moving average. As regular readers of our letter know, growth stocks, most from the technology sector, have dominated in terms of performance the last 10 years, which means their influence has grown significantly on market-cap-weighted indexes, like the S&P 500. However, value stocks are outperforming in 2021 YTD. Will this be the beginning of a trend reversal, or just short-term stock rebalancing?
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was up 5.17% in the second quarter, and up 8.83% YTD. Non-developed, or emerging countries (such as China, India, Brazil, or Russia) measured by the MSCI EM index, was up 5.05% for the quarter and 7.45% YTD.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, produced a 1.83% return in the second quarter, though performance YTD is still down 1.60%.
The 10-year U.S. Treasury bond yield was 1.45% at the end of June, which we think was a little bit of a surprise, given the bond was yielding 1.74% on 3/31/2021. The 1.45% was still higher than where it began the year at 0.93%.
If you plot interest rates versus the time-to-maturity to earn those rates, you have created a yield curve. We continue to monitor the changing shape of the yield curve for U.S. debt issues, and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government Bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep spread (long-term rates higher than short-term rates) indicates possible future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
The second quarter finished with the 2-year rate at 0.25%, which was slightly higher than where it was at the end of the first quarter at 0.16%. The 10-year, as mentioned, continued to move lower to 1.45%, causing the curve to flatten. Technically speaking, the curve is still upward sloping or considered a steep curve. The 120-basis point spread (a basis point represents 1/100 of 1%) is larger than where the year began, at 80-basis points, but below the first quarter reading of 158bp. Though steep, we think it is safe to say that the bond market is not signaling a definitive clear path for economic growth. Short-term rates moving slightly higher, but still basically pinned by the Fed, and inflation concerns growing while we see the 10-year bond moving lower in yield, is really creating mixed messages for this indicator.
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index had a very strong second quarter, up 12.03%, pressing YTD performance to 21.35%. YTD, this is the best performing index that we cover in our newsletter; last year it was the worst performing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate remains near all-time lows, dipping below 3.0% to 2.90%, with 0.6 Fees/Points (as of July 8th). The rate is subject to change and may not be offered in all areas or to all borrowers. Two years ago, at the start of 2019, the rate was 4.51% (close to a seven-year high). The lower rates may continue to have a positive impact on the housing market. For those who have a current mortgage and have not refinanced in some time, it may be worth looking at potential options. Our Baron Answers Video: Should I Consider Refinancing My Mortgage may answer some of your refinancing questions.
The Bloomberg Commodity Index (BCOM) increased in the second quarter, gaining 13.30%, increasing YTD performance to 21.15%. The positive performance in the last three quarters could appear to be positive indicators for an improving economy. But beware of any unexpected inflation.
Baron Client Strategies
As you read through this newsletter, you may notice that the two best performing indexes YTD are those representing Real Estate and Natural Resources. These were the two worst performing indexes in 2020. These market movements continue to present rebalancing opportunities for most client portfolios. As clients know, we are fiduciaries and operate as fee-only advisors, so there is no benefit to us for making investment transactions. The reasons we make trades are to align clients' portfolios with their customized, risk-appropriate diversified strategy, and because we believe the actions we take are potentially strengthening the clients' portfolios or financial positions. We use this same approach with our own personal money.
No matter the economic environment, our basic principles remain:
Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and obtain regular feedback to update information and advance your financial position.
Your Service Plan
One of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course, as necessary. If you have had any changes to your financial position or are considering changing financial goals and objectives, please let us know. For more specifics, check out our “What You Can Expect” document by clicking on the button below.
Your Personal Economysm
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved.” So, we have been including this section as a reminder of all of our services and to share ways in which we can help clients outside of investing.
Are you making a unique financial decision? Currently we are helping a client determine their options related to receiving a settlement. This is not something that we deal with every day but are happy to provide a "second set" of eyes and ears. Also, we have many contacts with professionals outside of those directly involved. If there is one thing that is standing out in this process, it is the importance of having other professionals to tap into when dealing with a major financial decision. For our clients, you are not alone when you have to make a unique or major "one-time" financial decision. Do not forget to include us in the process. We are here to help you.
Inflation, like all financial factors, does not impact everyone equally. Understanding what factors are most sensitive to you, helps you best prepare for a successful financial life and best position you in Your Personal EconomySM.
We always like to remind you that we focus on Your Personal EconomySM. Please keep in mind that our service also includes 2 hours of pro-bono advice to your children and grandchildren. All client and child information are kept strictly confidential. Let us know if any of your family members would like to meet to discuss their specific financial situation.
We have been creating more video content to help keep you informed and maintain a connection with your Baron Team. Hopefully, you continue to enjoy our video content.
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For more educational content, please visit our Website Blog. The Baron Advisors are often called upon by journalists for their insights on financial planning and investing. They are quoted in such prestigious media outlets as The New York Times, CNBC.com, and NJMoneyHelp.com, among others.
We are proud of our philanthropic efforts, which include pro-bono work, as well as monetary donations to The Fair Lawn Food Pantry, the All Faiths Food Bank in Sarasota, the Adopt-A-Soldier Platoon, Spectrum for Living (serving adults with developmental disabilities) and the SCARC Foundation Capital Campaign (serving people with developmental disabilities). In addition, we are proud to continue our eleven-year tradition of providing a Baron Financial Group Scholarship to two deserving Fair Lawn High School graduates (1 female and 1 male), who plan to further their business education. We are proud to help!
We hope to see you soon when safety allows!
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 9, 2021, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.