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Q2 2021 Market Highlights

Q2 2021YTD 2021
S&P 5008.5%15.2%
Barclays US Agg Bond Index 1.8%-1.6%

The US stock market continued its strong performance in Q2, with the S&P 500 finishing up 8.6% for the quarter and 15.2% for the year. Stocks have now gone without a -5% drop since last autumn. 

The 10 year US treasury yield fell 30bps during the quarter to finish at 1.45%. That drop fueled a 1.8% gain in the Barclays US Aggregate Bond index during the quarter. The drop in yield also helped growth stocks greatly outpace value during the quarter, up 10.9% vs 4.7%.


Inflation was a big topic during the quarter, with the Consumer Price Index increasing 5% year over year in May. This was the largest increase since 2008:

The Fed has argued that the increase in inflation is transitory due to pent up demand, hiring difficulty, and supply chain disruptions. The boom in lumber prices followed by its recent decline would seem to lend some credence to the Fed’s position:

On the other hand, inflation thus far has exceeded the Fed’s expectations and many commodity prices continued to increase. For example, steel prices in the US are booming:

Oil prices are near 5 year highs: 

I think the question of inflation is both a difficult one and an important one for investors. With asset prices and valuations high it’s difficult to find attractive assets to deploy capital into. However, if inflation continues at this pace cash will be painful to hold as it loses its purchasing power. 

Investor Optimism

According to a recent Global Survey of Individual Investors from Natixis Investment Managers, U.S. retail investors now expect long-term average stock market returns of 17.5% after inflation. That means investors now expect the market to earn roughly double its historical average return. These rosy expectations come in a market trading at its most expensive valuation levels in history. 

Investors’ portfolio allocation reflect these ebullient expectations, as portfolio allocations to equities are at highs:

Wrapping Up

Investors enter the second half of the year in a challenging position. Economies appear strong while reopenings are underway (with some exceptions for the Delta variant of Covid). Equities have done well and volatility has been muted. This has led to investors to overweight equities in their portfolios with unrealistic expectations for future returns. Meanwhile stocks in the US are as expensive as they have ever been. Alternatives such as junk bonds are priced for perfection, as yields on such bonds recently dipped below inflation (meaning investors will earn negative real returns). 

The specter of inflation has returned with many commodity prices booming and inflation indices picking up. That makes more defensive allocations increasingly unappealing and inflation will certainly be something to keep an eye on moving forward. 

Nevertheless, I still believe that prudence dictates a defensive approach in the current environment. An investor’s primary focus should be return of capital, not return on capital. 

Scott Caufield, CFA, CPA