Q2 2021

Market Recap



Things are starting to look very promising for our economy to fully open and for companies and investors to take advantage of the stimulus programs set before them. We constantly tell you that, “Bull markets climb a wall of worry.” That is what is going on currently.

Jeff Powell | CIO, Managing Partner Tweet
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The second quarter of 2021 was anything but typical. The S&P 500 had a terrific quarter, up 8.17%. These great returns were on the shoulders of a strong first quarter. The S&P 500 is now up 15.25% for the year. This return was found in the face of fears of COVID variants spreading, fears of inflation, the likelihood of a worldwide corporate tax, and the possibility of having state and federal tax increases.

The S&P 500 2Q 2021 Performance Chart
As we love to say, bull markets climb a wall of worry. This market is no exception. We began our “secular bull market” in 2013, as seen in the chart below. The average secular bull market lasts 14 years. It doesn’t mean that you won’t have short-term cycles within your secular bull market. Just look at the 1982 to 2000 secular bull market. We had the 1987 stock market crash, the 1990 recession, and 1994 was no picnic. For those sitting on the sidelines waiting for a major pullback in the markets before investing… you might be waiting a while.
S&P Composite Index
The returns that the S&P 500 provided came in the midst of a leadership “tug-of-war,” as growth (in black) has temporarily wrestled away control from value, although value (in purple) outperformed growth during the month of May. This back and forth has made it challenging to invest or take advantage of this short-term price movement.
S& P 500 Performance Returns
As you can see from the table chart below, growth outperformed value in the large and mid-sized companies during the second quarter. Small-cap value still outperformed small-cap growth for the quarter. Value continues to outperform growth across all three market capitalization categories.
Valie Table Chart
Commodity prices continue to be the top returning asset class for the quarter and the year. Long-term U.S. treasuries rebounded from their worst quarterly performance in their history to post a 6.46% return for the quarter, leaving them down -7.92% for the year. The only asset class not up for the quarter was the U.S. dollar. The U.S. aggregate bond index, gold, and long-term treasuries are the only asset classes showing a negative return for the year.
Asset Class Benchmark Performance

Ten of the eleven sectors of the S&P 500 provided investors a positive return for the quarter, with utilities as the only sector to lose value during the quarter. The top three performing sectors for the quarter were Real Estate, Information Technology, and Energy, up 13.1%, 11.6%, and 11.3% respectively.

Top Performing Finacnial Sectors
The MSCI All Country World Index (ACWI) was up 6.63% for the quarter, with the U.S. leading the way with the top regional performance. Only Japan showed a negative return for the quarter. The ACWI is now up 12.45% for the first half of the year.
MSCI All Country World Index Quarterly Performance Map
The S&P 500 remains historically overvalued by most measures. These readings are expected to normalize based upon future earnings expectations. A good investor would be wise to continue to monitor these readings, as they can also drop as a direct result of a pullback in the S&P 500.
S&P 500 Index: Forward P/E Rat
While the markets are considered to be overvalued, value investing remains closer to historical levels and has been improving. Large-cap growth and mid-cap growth, on the other hand, became more expensive during this last quarter.
Value is considered “cheap” as compared to growth in relative evaluations. We have returned to near-term valuation lows (value to growth), levels that we haven’t seen since the dot-com bubble era. While growth companies are much better positioned today than they were back in the late 1990s, a vigilant eye should be given to growth investments, because they are positioned to underperform value.
Value vs. Growth Relative Valuations
P/E Ratio of the Top 10 and Remaining Stocks in the S&P 500
The top 10 companies in the S&P 500 have driven the P/E ratio to 30.0. The historical average is 19.6, placing these companies at 153% of their historical averages. The remaining 490 companies in the S&P 500 are trading at a much more reasonable 121% of historical norms.

Polaris Wealth continues to be concerned with the weighting of the top 10 stocks as they are represented in the S&P 500. Currently, the top 10 companies represent 28.6% of the index’s weighting. This is a level we haven’t seen since the early 1980s. Why is this so important? Right now, the S&P 500’s performance as an index is completely driven based upon these 10 companies. And right now, these ten companies are overvalued. It is very possible that we could see the index correct and still have the majority of the companies in the S&P 500 have positive performance. When you hear us talk of, “We aren’t buying the market, we are buying companies in the market,” this is exactly the point that we are trying to make. These ten companies might drive the index down in value, but it doesn’t mean that we have to see the same downside in our investments.

Weight of the Top 10 Stocks in the S&P 500
Inflation became all the talk when May’s inflation rate moved up to 3.8% from 1.6% just two months earlier (graph below). The Fed has kept rates at 0 to 25 bps, stating they feel that these new readings are transitory, meaning they won’t last long – that they are just rising due to bringing the world’s economy back online after being shut down for COVID.
The Fed Interest Rates

The four graphs below are illustrative of our current situation. Lumber (top left) dropped to $200 per 1,000 board feet during COVID. It then ran up to almost $1,700 per 1,000 board feet in early May, only to fall to $700 now.

This is a perfect example of how demand outstripped supply due to COVID. During COVID, lumber mills were shut down. As we began to open our economy, our population moved from cities to the suburbs, because people wanted more space, they wanted a yard. This created demand for more houses, pushing the prices for lumber up. It wasn’t until the lumber mills fully opened that they could meet the demand. Once they were able to meet the demand, prices fell back to more normal levels.

The other commodities, Brent oil, poultry, and wheat give you an understanding of where prices have gone over the last year. Brent oil prices have gone up in value as the world’s economies have come back online. More demand, higher prices. Poultry prices are similar to what happened with lumber, tied with economic stimulus. Poultry plants shut down due to COVID. The economic stimulus packages are so rich in the United States that it is hard to motivate workers to go back to work. Even though these plants have reopened, they are working below capacity.

Commodity Prices
Polaris Wealth has written a lot about how gold and silver are not great hedges against inflation or a currency crisis. As you can see from the charts below, both gold and silver are down for the year and have dropped in value since the initial fears of inflation took hold a few months ago.
During that same time, the U.S. Dollar index has gone up in value, the exact opposite of what should happen if inflation has taken hold.
The U.S. economy has struggled and is just now getting its head above water, after several quarters of negative economic activity.
U.S. Bureau of Economic Analysis, National Bureau of Economic Research
Even so, the U.S. economy is not back to where it was prior to the COVID-19 worldwide pandemic and subsequent economic shut down, as seen below.
U.S. economy
Unemployment has begun to normalize but still remains well above pre-COVID levels in 2019.
Civilian Unemployment Rate and Annualized y/2y Growth for Private Production and Non-Supervisory Workers
June Jobs One-Month Net Change
The majority of jobs created were in the industries that lost the most amount of jobs when the pandemic hit. As you can see, many people rejoined the leisure and hospitality industry, which was struck the hardest of all industries.
One major concern is the number of unfilled open positions throughout the United States. We have hit levels that we have not seen before. A lot of pundits blame the rich stimulus package provided to the unemployed. They say that they are making more being unemployed than if they went back to work. We shall see how these unfilled openings change as unemployment benefits end.
US unfilled open positions
And it will be interesting to see how much of the American population rejoins the work force. Right now, we are at levels not seen since the mid-1970s. Some of this can be directly correlated to “baby boomers” retiring. We are still approximately 3% smaller workforce than we were before the pandemic.
American population rejoins the work force
The Fed has kept rates at zero percent (as seen below), citing that they want to see specific economic figures before they will consider raising interest rates. Given that we have not fully recovered from our recession, I agree with the Fed’s stance on interest rates. Keep them low. Ensure that we don’t fall back into a recession. Drive economic growth and prosperity.
The Fed Reserve Interest Rates
While there appears to be virtually no chance that the Fed will make a move by their December 2021 meeting, all bets are off when looking out to February 2023 Fed Futures. There is only a 25% chance that rates will be left where they are. There is an equal chance that rates will be raised twice to 50 to 75 basis points, with the highest probability that they will make one move.
Fed Futures
As we’ve discussed at great length for years, a rising interest rate does not serve bond investors well. The chart to the right illustrates the negative impact that a one percent rise in interest rates could have on the performance of different types of bonds. As you can see, there are almost no favorable outcomes. If the Fed has told you that they can’t raise rates now, but they will most likely start raising rates in 2023, shouldn’t you act on what they’ve told you is their game plan?
The Fed Interest Rates
Nominal and Real 10-Year Treasury Yields
As it is, the real yield (the amount you get after accounting for inflation) for a 10-year treasury has hit negative levels we haven’t seen since the late 1970s.

Second Half Outlook

We remain very bullish for the second half of 2021. The U.S. daily new infection rate (chart on the left) has dropped to just over 13,000 a day, while daily deaths (chart on the right) have dropped to approximately 250.
U.S. daily new infection rate
While we have not hit herd immunity levels, it is obvious that our immunization program has dramatically dropped the spread of COVID. While there is an expected resurgence in the fall when kids go back to school, it is not expected to have a material economic impact. Source: Centers
The Path to Herd Immunity in the U.S.
Analysts have set their expectations for earnings for 2021, 2022, and 2023. As you can see from the chart below, they are expecting a very strong 2021 and 2022, with a slight tapering off of earnings in 2023.
S&P 500 Projected Earnings Per Share
With these kinds of future earnings, there is a strong chance that forward P/E ratios will normalize in the years to come. If valuations remain high, it will be as a result of strong price movements in S&P 500 companies, which is good for investors.
S&P 500 Index: Forward P/E Ratio
Valuations still strongly favor value oriented stocks, or those that pay a dividend. As you can see from the regression chart below, value stocks are 22% undervalued to where they should be based upon regression analysis for 2021 and 27% from where they should be at the end of 2022. Growth stocks, on the other hand, are 8% overvalued for 2021 using the same evaluation and 3% overvalued for 2022.
Large-Cap Stock Valuation by Dividend Policy

There have only been 14 times that the S&P 500 didn’t experience at least a 5% pullback during the first half of the year. 2021 is now the 15th time that this has happened in the S&P 500’s modern history, only experiencing a 4.2% pullback beginning in February and ending in early March.

1H 2021 S&P 500 Price Movement
In years that didn’t have a 5% pullback, 13 of those 14 years, the S&P 500 experienced a positive return during the 2nd half of those years, with a median return of 10.2%. The only negative year was 1986, which experienced a 3.5% negative return. This certainly bodes well for a strong second half in 2021.
2nd Half Performance in Years Without a 5% Pullback in the 1st Half
You might not have noticed, with all of the news providing nothing but things to worry about, but the S&P 500 has had five straight quarters of 5% or greater performance. This has only happened once before, since WWII, and that was in 1953/54.
Consecutive Quarters of 5%+ Gains for S&P 500: 1945 - 2021
As you can see from the chart below, our current performance is slightly better than it was for that similar run in 1953 into 1954.
S&P 500: Q4 1953 - Q4 1954 vs Q2 2020 - Q2 2021
The following twelve months, even though the streak was broken, produced an outstanding year of market performance, providing investors a 26.4% return.
S&P 500: Q4 1953 - Q4 1955 vs Q2 2020 - Q2 2021

We see strong performance in the stock market, especially for areas that are still undervalued or at the very least aren’t trading at record highs. This said, there is still risk in the markets. The most pressing issue that we see is the mutation of COVID-19. We can only hope that those complacent to get their vaccination will do so soon. We need all Americans to treat getting vaccinated as something that they are doing for the greater good of our country and humanity. And we can only hope that the millions of doses that are being manufactured daily are distributed far and wide so mutations of COVID-19 will be limited. We expect the United States and most countries in Europe
to be at herd immunity levels by the end of this year. Russia, Australia, and most of South America should be at those levels by mid-2022, and most Asian countries should be at herd immunity by the end of 2022. Only the poorest countries, with the lowest levels of medical support should be receiving vaccines into 2023. As of July 4th, 3.2 billion doses had been administered worldwide. 

Things are starting to look very promising for our economy to fully open and for companies and investors to take advantage of the stimulus programs set before them. We constantly tell you that, “Bull markets climb a wall of worry.” That is what is going on currently. 

Markets can be fickle. If we were to see a shift in sentiment, Polaris Wealth would do what we do best, and that is to tactically manage the risk in the markets. We are vigilantly evaluating the markets to take advantage of current trends, and we are always keeping an eye out for things that would reverse the markets’ upward trend. Given what we know at the moment, things look good for the market.