QUARTERLY UPDATES - Coral Gables Trust Company

Q2 2021 the big picture


Q2 2021 - The Big Picture 
The market has brushed off wide swings in economic data, a spike in inflation readings and uncertainty about the direction of fiscal and monetary policies.  While equities have been resilient across nearly all regions and sectors, one prevalent trend is value stocks outperforming growth stocks on a YTD basis through June.  The improving Covid-19 backdrop is leading consumers to venture back into public and purchase services they went without for more than a year has provided a tailwind to value.  Whether this trend is sustainable will largely depend on the technology sector performance and the valuation investors are willing to pay for these companies.  The S&P 500 ended the quarter closing at all-time highs, with a +8.55% return.  Despite inflation fears, the technology heavy NASDAQ remains resilient with a +9.68% return for the quarter.  The market appears to be in a tug-a-war between elevated valuations and earnings growth.  Second quarter earnings expectations are high and will need to deliver to justify current market valuations.  To sustain these market gains going forward, earnings guidance will become more important than ever as we naturally begin to move away from the lower Q1 2020 and Q2 2020 calendar comparisons.
On the economic front, the employment data released for the quarter was better than anticipated with the unemployment rate dropping to 5.80% compared to the 6.20% experienced in the first quarter of 2021. May's employment report highlighted a full force recovery with another 840,000 jobs added to the economy. However, the report understates the potential for robust job gains in the months ahead, as employment growth continues to be restrained by generous federal unemployment benefits and lingering pandemic worries.  Thus far, twenty-five states have ended these supplemental unemployment benefits instead of waiting until they expire nationwide on September 6th..  Given the Federal Reserve's economic projections, we believe there is a possibility that real economic growth will be stronger, unemployment will be lower, and inflation will be higher at the end of the 2021.  This could ultimately force the Federal Reserve to not only taper bond purchases sooner but raise interest rates earlier than forecast.  Inflation data in the months ahead will determine the course the Fed takes.
Despite investor inflation anxiety, the bond market has reacted in a counterintuitive manner by rallying in the late weeks of the second quarter. The 10-year U.S. treasury rate has settled into a narrow range, ending the quarter at 1.47% which is a far cry from the high reached earlier in the year.  The question of transitory or sustained inflation is significant because of what it means for future actions from the Federal Reserve and the impact on the market.  The key tool the Federal Reserve uses to balance high inflation is raising short term interest rates.  Ultimately, this is negative for bond prices and prolonged rate increases act as a headwind for equities.  With the Federal Reserve's willingness to accept elevated levels of inflation, we do not expect significant interest rate movements to occur in the near term.  As a result, we expect bond performance to remain relatively muted with most of the performance derived from their underlying coupon rate.  Foreign bonds were up +0.86% for the quarter, while the performance of the Barclays Aggregate Bond Index was slightly better for the quarter with a +1.83% return.
Across the pond in Europe, the shape of their economic recovery will largely be a function of the vaccine rollout.  The recent performance of European equities may reflect a general belief that the continent will be the next beneficiary of vaccinations and reopening.  International markets continue to underperform the U.S. but have been more correlated with the U.S. this year than previous years.  The MSCI ACWI ex-US index returned +5.64% for the quarter and the MSCI EAFE index returned +5.38% for the quarter.  Given the relative valuation advantage abroad compared to the U.S., international exposure remains an important component within a diversified portfolio.
Undoubtedly, we are in an economic growth phase as investors remain steadfast in buying the slightest of market dips without hesitation.  Our Investment Committee believes market performance can continue to grind higher from these levels as fundamental data continues to improve.  However, corrections inevitably happen in bull markets and are typically driven by factors that come as a surprise.  While safe assets always feel like wasted opportunities during periods of significant market increases, their defensive nature acts as a ballast for when the tide turns.  In Q2 our Investment Committee held steady with our allocations and manager selections.
We remain confident that we have selected superior managers, which will protect and perform regardless of market conditions.  Our Investment Committee believes that our current managers are poised to benefit from long-term and attractive investment themes.  Listed below is a subset of our equity and fixed income managers that performed exceptionally well versus their stated benchmarks in the second quarter. 
We look forward to speaking with each of you regarding our views and the performance of your respective portfolios.  For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Michael Unger, Investment Officer, at 786-292-0310

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