Please find the next blog in our monthly series that provides a review of the prior month’s market data, the state of the economy, and the global financial markets.
The spread of the Delta variant led to renewed concerns around Covid in July, with equity returns mixed and volatility higher despite a strong beginning to 2nd quarter earnings results and positive economic data. US GDP data underwhelmed given high expectations, but growth was still robust and GDP has surpassed pre-pandemic levels. US inflation continues to run higher than expected but is still viewed by the Fed as transitory. Nonetheless the Fed’s tone has shifted to be moderately more hawkish in recent meetings. Covid-19 cases are on the rise both in the US and worldwide as the highly contagious Delta variant becomes the dominant strain. Markets will remain susceptible to pullbacks as governments continue to deal with new variants and the possibility of new restrictions is a risk for global growth, but many regions are learning to navigate the coronavirus without the large-scale restrictions of the early-pandemic.
The Federal Open Market Committee met in July but did not change policy rates, a widely expected outcome. The timing of the tapering of asset purchases is increasingly a subject of debate, and the meeting statement acknowledged the economy “has made progress” toward the committee’s goals but “the Committee will continue to assess progress in coming meetings.” Analysts generally expect tapering to commence in late 2021 or early 2022, but for now the Fed continues to expand its balance sheet by at least $120 billion a month.
The first estimate of 2Q-21 real GDP indicated the US GDP expanded at a rate of 6.5% annualized. This was somewhat lower than consensus estimates of 8.5% but was still enough to push GDP above its pre-Covid peak. The increase was largely due to increasing personal expenditures, which rose 11.8%. Nonresidential fixed investment, exports, and state and local government spending also contributed. The Atlanta Fed’s quantitative GDP model currently forecasts continued robust growth of 6.0% in 3Q-21, in-line with analysts’ consensus estimates which range from 5% – 9%.
Weekly initial unemployment claims continue to hover around 400,000 as the highly contagious Delta variant threatens to slow the return of workers to the labor market. For the month, 943,000 jobs were added for the largest gain in 11 months. June payrolls were revised up significantly as well, and unemployment dropped 0.5 ppt to 5.4%. Core CPI rose again to +4.5% as base effects appear to be peaking and rising demand continues to collide with supply chain issues. Core PCE also rose to +3.5% year-over-year through June.
Returns for major equity indices were mixed in July. US large caps and Non-US Developed were up, and US small caps and Emerging Markets were down as concerns over the Delta variant and signs of peaking growth weighed on risk appetite. The S&P 500, which represents large US-based entities, returned +2.4% for the month. Health Care (+4.7%) Real Estate(+4.6%), and Utilities(+4.2%) were the strongest performers with most sectors positive. Energy (-8.4%) was a notable laggard as it was hit hardest by growth concerns. The Russell 2000, representing small cap stocks, returned -3.6% in July. Utilities (+2.6%) and Real Estate (+1.8%) outperformed, with the rest of the sectors negative on the month. Energy (-12.8%), Communication Services (-12.5%), and Health Care (-7.02%) all lagged. Style performance was mixed, with large cap value lagging growth and small cap performance consistent across styles in July.
In the broad international developed markets, the MSCI EAFE index returned +0.8% for the month. At the sector level, Materials (+3.7%), Information Technology (+3.2%), and Industrials (+2.0%) were the top performers while Energy (-3.3%), Communication Services (-3.3), and Consumer Staples (-0.3%) lagged. Among developed countries, Finland (+5.9%), Israel (+4.9), and Denmark (+4.9%) were the top performers while Hong Kong (-2.9%), Belgium (-2.0%), and Norway (-1.8%) lagged. Most countries posted modest gains, as an accelerating vaccine rollout in the developed world allayed some fears of renewed restrictions.
Emerging market stocks, as represented by the MSCI Emerging Markets index, lagged with a return of -6.7%. The segment was dragged down by low vaccination rates amid the rise in Covid cases, as well as announcements of tighter regulations in China which triggered sharp declines. At the country level, Egypt (+7.0%), Turkey (+6.6%), and Argentina (+6.4%) outperformed while China (-13.8%) was a notable laggard at 35% of the index.
Real estate, as measured by the FTSE EPRA/NAREIT Developed index, outperformed equities with a +3.9% return. The energy-related Alerian MLP performed in-line with Energy sector equity at -6.3%, while the near-month NYMEX oil returned 0.7%. Gold was up 2.3% but is still off -4.4% YTD, while the diversified Bloomberg Commodity index was up 1.8% to push YTD returns to 23.4%.
US Treasury yields continued to fall in July with a flatter curve. The 10-yr yield dropped 25 bps to 1.22% and the 10’s minus 2’s curve flattened 18 bps. The overall UST complex returned +1.6% for the month, lifting trailing one-year returns to -3.0%. Globally, developed market yields were generally lower with flatter curves, as long term-yields fell due to Covid-driven growth concerns. The global stock of negative yielding debt rose substantially to $16.3 trillion from $13.4 trillion.
The BloomBar US Aggregate Bond index underperformed risk-free US Treasuries on an absolute and duration-matched basis with a return of +1.1% in July. Underperformance relative to treasuries was broad based for the index, as spreads widened modestly across investment grade sectors due to uncertainty caused by the spread of the delta variant. However, sector returns were generally positive in July, and the benchmark’s yield-to-worst fell 14 bps to 1.36%.
The BloomBar 1-15-Year Municipal index returned +0.7% in July. Demand remains supportive, with YTD inflows to municipal funds that would already qualify as the third highest full year amount. Demand combined with relatively light supply to produce a favorable technical tailwind in the month. A bipartisan agreement was reached on the long-discussed infrastructure bill in late July that is expected to advance a vote in August. This plan would provide $548B of new spending over five years on infrastructure needs but also lacks some provisions favored by muni participants like the inclusion of direct-pay bonds (like the Build America Bonds of 2009) or the reinstatement of advance refunding.
The BloomBar US Corporate High Yield index returned +0.4% for the month. High-yield spreads widened 26 bps to 294 bps, which still leaves the sector 66 bps tighter YTD. The benchmark yield rose 13 bps off the all-time low it hit last month to end at 3.88%. The TTM default rate is expected to have fallen to 1.4% by the end of July, the lowest level since March 2014. Emerging Market debt underperformed other fixed income sectors amid the month’s modest decline in risk appetite, as concerns over the impact of the Delta variant led to EM spread widening.
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