International and Global Markets Commentary & Investment Outlook
Equity markets performed strongly in the second quarter. Nearly all sectors and regions benefited, though the U.S. continues to lead relative to international developed and emerging markets. Notably, growth stocks outperformed value stocks (aside from emerging markets), which was a reversal of the trend from the first quarter, but not a complete unwind of that massive rotation.
Monetary and fiscal stimulus, economic reopening, and rebounding corporate earnings continue to be tailwinds for stocks. Inflation normally coincides with strong economic expansions, and it has been often cited as the primary risk to the market rally. We have made ongoing adjustments to portfolios by emphasizing holdings that we believe are well-suited to transmit pricing power or are valued more attractively. These attributes should help protect portfolios from deleterious inflationary pressures.
Last year, the Federal Reserve (Fed) adopted a new approach to setting interest rates by targeting average inflation of 2% over time. It also aimed to let inflation run moderately above that level for a while, after many years of inflation shortfalls. Personal consumption expenditures (PCE) inflation reached 3.6% in April and 3.9% in May. The spike in inflation has been quicker and stronger than expected, but it is chalked up to transitory factors such as low base effects, supply chain bottlenecks, and pent-up demand. As things get back to normal, inflation should moderate. The Fed expects inflation to slow to 3.4% by the end of this year and to hover modestly above 2% in 2022 and 2023.
Most Fed officials are more comfortable that the U.S. will be able to achieve maximum employment and sustained 2% inflation on a quicker timeframe than originally expected. Labor markets are improving. Industry breadth is at its greatest point since the pandemic started, and there is still further room for recovery in the industries adversely impacted by the pandemic. The latest data shows an unemployment rate of 5.9%, which is roughly 7.6 million jobs lower than pre-pandemic levels. The long duration of enhanced unemployment benefits has been cited as one of the main reasons for the difficulty employers have faced filling jobs, yet unemployment levels have still remained elevated. These enhanced benefits are set to expire in September, which may help these frictions release.