Chief Investment Officer and President, Greg Hahn, sits down with Portfolio Manager, Adam Coons for another episode of Winthrop’s “Weekly Insights” podcast. Tune in as they discuss our outlook for the markets as the Fed shifts fiscal policy and the economy continues to reopen to full capacity in the second half of the year.

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Greg Hahn: So we’re coming up on the half-way point of the year. We’re looking forward to the second half of 2021. If the year ended right now, it would be a pretty remarkable year, especially for domestic equity.

Adam Coons: S&P is up 12.5%.

GH: And I think Europe is up the same. By any stretch, that’s historically a pretty good year. 

AC: Yeah, Germany is up 14%, France is up 18%. 

GH: What does the second half look like, given where valuations are today and the potential for fiscal stimulus to come?

AC: Fiscal stimulus is one of those things that we need to keep propping up the market. But from a valuation standpoint with the S&P still in the 30’s, there’s really not much more room for this to go because a lot of the future growth has already been baked in. I think that’s what we’re seeing with technology lagging this year. Technology really accelerated in 2020. We saw multiple expansion there, and now it’s slowed down.

GH: I think the key is going to be the Fed. Regardless of whatever is going on with inflation right now, the Fed feels that the economy is growing fast enough and employment is fixing itself. They may start to shift policy, which will cause some disruption in both the bond market and the equity market. 

AC: Yeah, I was doing some research over the weekend. Getting a little bit into the weeds, we’ve gone about 3 months with almost zero repo transactions, but in the last 30 days there has been a significant spike in repo transactions, which happened the last time they tapered. 

GH: I don’t think the 10 Year Treasury has that priced in. 

AC: Not at all. No. 

GH: Then ultimately, what rising rates means for the equity market, according to last time with the stretch from 2016 to 2018 – the market did not handle that well. The Fed’s balance sheet and the shift in policy I think is going to be a key driver in the second half of the year.

AC: Higher interest rates would undo the narrative on why valuations are so high, while low interest rates justify it. So you’ll see an unwind.

GH: It is too early to really predict, but I am looking at retail thinking that this is going to be a heck of a holiday shopping year. Have you been into any stores lately? I was in Nordstrom Rack, and the shelves were empty. I mean, inventory is way down. 

AC: Especially those discount retailers – TJ Maxx and Marshall’s. Inventory is not there. 

GH: Right. As the economy opens up and retail has its legs underneath it, I think we’re going to see a big increase in inventory. I think it’s going to continue into the holiday shopping season.

AC: That’s the case. You’ve got still a very high savings rate across consumers. The problem is that they just don’t have anywhere to spend the money. Concerts and movies haven’t come out and really been an option. Same thing for shopping. People are going shopping but may not be able to find what they want to buy. Even bigger ticket items like TV and furniture are usually on a pretty long waitlist. That is what is leading to savings rates are remaining elevated. 

GH: I heard a statistic this morning that there are as many open positions today as there are unemployed persons. I’ve got to fact check that one, but if that’s true, I think the reopening is going to accelerate as we move off of the additional unemployment incentives. Demand for labor heading into the second half of the year is going to force wages higher. 

AC: Yeah, I don’t see how it doesn’t. There is a lot of friction in the market right now. Job openings keep going up, yet the unemployment rate is not quite going down at the same rate. It’s interesting. 

GH: One of the things we will unpack next week is the 5 stock picks for the second half of the year. Do you have any thoughts on that?

AC: From my perspective, it’s going to be a lot of the same, but maybe a higher tilt towards China, personally. 

GH: So, why is that?

AC: I keep coming back to – and you say the same thing – when you look the globe over and ask if the US is really the only place for growth. I think the answer, more and more, is shifting to no. We’re seeing that our economy – I wouldn’t call it “stuck” – but there are only so many levers we can pull. China, on the other hand, has a global strategy of growth, and right now it seems like it’s working.

GH: What’s on your plate this week?

AC: On the equity side, earnings have pretty much wrapped up. And a good earnings season. There was a fairly low bar, but that bar has continually gone up through this earnings season, which worries me going forward with valuations high. But, over the last three months, the S&P 500 is up 7.88%. Really, the place where you’re seeing some laggards is in Small Cap. In the beginning of the year, they took off, but over the last three months its up less than 1%, so a significant underperformance compared to domestic Large Cap. Emerging markets have also lagged, which has primarily been China weighing that down. So we’re looking into shifts in allocation going into the second half of the year for our allocation to Small Caps, as well as China and Emerging Markets as a whole.

GH: How does stock buybacks weigh into the second half of the year now? So we’re past the banks can start to buy back their stock. We’re past this whole period of record levels of the S&P 500, but it seems to me there has been an increase in dialogue around stock repurchases – Oracle, Bank of America, Goldman Sacs. 

AC: I think it’ll depend on rates. As long as rates are low, you’re going to see these corporations issue as much debt as possible, simply to buy back their stock. That’s why Oracle had their big issuance, and you’ll see that banks continue to issue to do that. Apple, Microsoft, and other names will continue to do the same, and I don’t see anything slowing that down.

GH: Heading into the end of the quarter, we’ve made a few changes to our Portfolio Models. What do you see in our Portfolio Model suite right now? Any changes that you’re anticipating?

AC: Through the last several months, we’ve increased the safety bucket with Low Volatility and Equal Weight ETFs. We’ve maxed that trade out, and will likely begin to unwind that. On the Emerging Markets side, we will continue to build out the China piece of our portfolios. It’s the Alternatives that are the big question mark. We’ve spent a lot of time looking at Real Asset funds and trying to find other asset classes outside of your typical bond and equity. It continues to be a struggle to find anything that’s really investable.

GH: I talked to Freddy about a Europe focus in the developed areas instead of just the broad MSCI. He pointed out that Europe has done just as well as the S&P. But, it’s got a long way to go, and I think they’re at the front end of their recovery and the economy opening up to the point where the summer tourists season could be saved. There might be something there. 

AC: The other piece I would say is the Preferred space. Preferreds have had a really good year, up 10% over the last 12 months. We were going through whether normalized returns for preferreds, when you think of the coupon, generically speaking return around 5%. But if they’re up 10%, they’re probably a little bit extended, so that is one that we would cut back. 

GH: So in our models, we would sell down the preferreds. In our Preferred Stock SMA strategy, we will begin to play defense and shift to more defensive names and structures. What else is going on in the markets?

AC: Fixed income markets are about as boring as they could be. I mean, the 10 Year has been stuck at 160 for 3 weeks now. Not a lot to report there.

GH: I’m surprised it’s not higher. That’s just giving us time to shift the portfolios around. Anything else from your end?

AC: Nothing here. 

GH: Thanks for listening, and we’ll talk to you throughout the week. 

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