Portfolio Management Archives | Page 16 of 22

Turbulent times for Bitcoin and other cryptocurrencies

In May, Tesla CEO Elon Musk sent shockwaves through the cryptocurrency market when he tweeted that Tesla had suspended its practice of accepting Bitcoin for vehicle purchases and that it would halt sales of the Bitcoin it had purchased. It was a startling change because, as we wrote in February, Tesla helped Bitcoin surge to a record high when it bought $1.5 billion worth.

The reason for Musk’s recent reversal: the environment. “We are concerned about rapidly increasing use of fossil fuels for Bitcoin mining and transactions, especially coal, which has the worst emissions of any fuel,” he wrote.

Confusing, right? How can Bitcoin and other cryptocurrencies, like Ethereum, be bad for the environment?

A report by Cambridge University states that Bitcoin mining uses 116 terawatt hours of energy consumption per year, which equals .5% of total global electricity consumption. (By the way, 1 terawatt equals 1 trillion watts.) To put that amount into context: Bitcoin miners use more energy than several countries, including Singapore and the Netherlands. In fact, if a country used that much energy, it would be in the top 35 of all countries in the world for energy consumption.

As the price of Bitcoin rises, more miners are logging in and mining for it and other cryptocurrencies in the hopes of becoming rich. For those areas of the world that rely on fossil fuels for energy versus renewable energy, more mining means more “dirty” energy consumption, which is worse for the environment. This is especially notable because roughly 65% of all mining for cryptocurrency takes place in China, which is the world’s largest greenhouse gas emitter.

China and the U.S. are cracking down again on the business of mining cryptocurrency and warning about the speculative nature of the currency. Last week, authorities in China ordered cryptocurrency miners to shut down their operations in the Sichuan province. This is not the first time China has taken action; in 2017, officials issued similar edicts forcing cryptocurrency mining offshore from mainland China.

Then on Monday, the People’s Bank of China urged Alipay not to provide services related to cryptocurrency activities, including account openings, clearing or settlement. This move sent shockwaves through the cryptocurrency markets and thus, the price of cryptocurrencies has seen extreme volatility the last few weeks. As seen in the chart below from JP Morgan, the opinions on cryptocurrency’s long-term possibilities remain widely varied — which contributes to volatility, as different cryptocurrencies are used as trading vehicles, hedges against inflation and for pure speculation.

So, what can we learn from all this? Bitcoin and other cryptocurrencies are still relatively new, as they have been around for a little more than 10 years. They remain a very risky investment that may or may not pay off. Investors should invest only as much as they are willing to lose, and if one does invest, it should be part of a well-diversified portfolio.

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time and downturns present opportunities to purchase stocks at a lower value.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. Regarding investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: CNBC, DW.com, JP Morgan Chase

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management. Investor Disclosures: https://bit.ly/KF-Disclosures

The portfolio changes we’re making as we enter the third quarter

We’re almost to the midway point of 2021, and what an interesting first half of the year it’s been:

* Thankfully, the economy continues to reopen as more and more people receive their COVID vaccinations.

* Demand continues to outstrip supply for many goods and services, which is leading to higher prices.

* Travel has picked up as people resume their lives, and home prices continue to soar — along with construction costs.

* Meme stocks and cryptocurrency continue to dominate the financial news.

* Interest rates remain near zero, while the 10-year Treasury remains close to 1.5%.

The S&P 500 (stock market) momentum continues to be positive, led by financials and energy, as investors currently favor value over growth. The chart below reflects the different sectors that comprise the S&P 500 over the last year. Energy, Materials and Information Technology are the only sectors that have been the best-performing sector for more than one month. Financials have had the strongest 12-month return but led the S&P sectors in only one month (December).

Chart showing sector movement over the last 12 months

We are reallocating and rebalancing the portfolios and making the following changes for the second half of 2021:

1. We are reducing our exposure in healthcare to a market-weight level from an overweight position. We continue to believe strongly in the healthcare sector for the long term, thanks especially to new innovations, as we saw last year with the rapid production of the COVID vaccine and recent approval of an Alzheimer’s drug.

2. Financial stocks remain inexpensive on a price-to-earnings multiple basis, and we are adding additional exposure to the asset class. We believe that small stocks will continue to benefit from the economic reopening, and we are increasing our current allocation. With both moves, we continue to balance growth and value in the portfolio.

3. From a fixed-income perspective, we are further reducing our current weighting in high-quality corporate bonds and adding to our strategic income fund that provides diversification to different asset classes within fixed income. As interest rates rise, certain segments within fixed income invest in bonds that rise with higher rates and provide increased flexibility within the portfolio.

Our focus remains on long-term investing with a strategic allocation while maintaining a tactical approach. Our decisions to make changes are calculated and well thought-out, looking at where we see the economy heading. We are not guessing or market timing. We are anticipating and moving to those areas of strength in the economy — and in the stock market. We strategically have new cash on the sidelines and buy in for those clients on down days or dips in the market, like one does through a 401K every other week. We speak with our clients regularly about staying the course and not listening to the economic noise and trading meme stocks.

In the short term, the outlook for the global economy looks strong. The Federal Reserve bank has reiterated that it plans to allow inflation to increase for the foreseeable future and is unlikely to raise short-term interest rates in the near future. The Fed also is closely watching employment numbers and adjusting the money flow and bond purchases based on job reports.

So, what can we learn from all this? We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Source: Schwab

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

‘Meme stocks’ are moving; are they a good investment?

The term “meme stocks” seems to be making a daily appearance in the news: stories of young investors trading on companies that are on the verge of bankruptcy and promoting large gains and losses. BANG stocks, a spoof on the fabled FANG stocks (Facebook, Apple, Netflix and Google), are now Blackberry, AMC Entertainment, Nokia and GameStop. These stocks continue to see excessive trading volume from retail investors who have targeted them on social media.

Dogecoin, which started as a cryptocurrency parody, is another example of a meme stock and has seen its value skyrocket on Elon Musk’s tweets. The chart below highlights meme stocks and their growth in market capitalization based on the rise in stock prices year-to-date. AMC has seen its company market capitalization rise an astounding 7,296% in the first five months of the year.

For most investors, the phenomenon of meme stocks has no real impact. If GameStop or AMC were to come crashing back to Earth, it is more than likely that this would have very little impact on the overall market. These stocks were first targeted on a Reddit forum titled “Wall Street Bets,” which looks at the most heavily shorted stocks on Wall Street. The reason institutional investors short a stock is that they believe the stock price is too high and the company is fundamentally flawed and overvalued. Short selling occurs when an investor borrows shares and then immediately sells them, hoping to buy them back later at a lower price. When investors buy the stock back, or “cover the short,” they return the shares to the lender and hope they can profit if the shares have gone down in price.

A short squeeze is when a short seller — someone betting against a stock — is squeezed out of their position by excessive price action to the upside. A group of investors on social media is targeting a company, like AMC, that currently has tremendous, short interest. (This means that many investors are “shorting” the stock in the hopes that the stock price drops.) All the while, retail investors are buying the stock and purchasing call options, pushing the stock price higher and in turn, forcing the investors who are trying to short the stock to sell. This action forces the stock price even higher.

Meme stocks remain a very risky trade, as this group of stocks are not investments — they are gambles. These companies are not trading on underlying financial results and prospects. Regulators, like the Securities and Exchange Commission, are beginning to take a closer look at social media activity and its impact on the financial markets. If rules are implemented on investment content or group coordination, meme stocks could face stiff regulation limiting potential upside and possibly causing these same stocks to crater. Meme stocks carry much higher risk because of their reliance on social media, and while there may be instances of traders making money, you are more than likely to lose.

So, what can we learn from all this? Trading in meme stocks brings a high amount of risk, and those who want to buy the BANG stocks should be prepared to lose their investments. Remember the first rule of gambling: Never gamble what you can’t afford to lose.

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. We believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: Marketwatch, Yahoo Finance

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Capital gains strategies, regardless of Biden’s plan

Last Friday, President Biden unveiled detailed explanations on how the administration plans to pay for the new $6 trillion budget. The biggest surprise in the proposal is that the administration is seeking a retroactive effective date on a capital gains tax rate hike from 20% to 39.6% for households making more than $1 million. If you add in the net investment income tax for high-income earners, this raises the top long-term capital gains tax rate to 43.4%, up from the current 23.8%.

“This proposal would be effective for gains required to be recognized after the date of the announcement,” the Treasury Department said, referring to an address to Congress on April 28. The purpose of the backdating proposal is to avoid a sell-off ahead of the capital-gains rate hike, if it were to be approved.

A historical review of legislation suggests tax-rate decreases are easier to implement on a retroactive basis from a policy and political standpoint. With life’s only certainties being death and taxes, the tax implications of a transaction would ideally be known at the time of the event — and not retroactive.

As we wrote about last week, tax changes are far from certain, and a lot of ideas are being thrown around in Washington. We are approaching our financial planning with maximum flexibility. It is safer to plan for what we know, rather than what we don’t know, and that is our approach. We believe the proposals in their current state will not pass through Congress, but we also cannot begin to predict precisely what will pass.

Having said that, the following are capital gains tax strategies that we already use for your benefit:

1. Donating appreciated securities to charity or a donor advised fund. This is a tax-smart way for those who are charitably inclined to donate money. The market value of the security on the date of donation is a charitable tax deduction, and there are no capital gains taxes on the donated assets.

2. Tax loss harvesting. This strategy involves realizing tax losses on holdings and then using those losses to offset realized gains. Any remaining losses incurred in a year can be carried over to subsequent years and help offset future capital gains.

3. Converting traditional IRA assets to Roth IRA. This works well for those in lower income tax brackets. Investing in stocks with higher growth potential in a Roth IRA will negate any taxation of future capital gains. There are no taxes in the year of the gain, and the money can be withdrawn tax-free at retirement (if certain rules are followed). Also, assets in an inherited Roth IRA are tax-free to beneficiaries upon withdrawal if the five-year rule was met prior to death. This includes capital gains that were realized in the account along the way.

So, what can we learn from all this? Avoiding potentially higher capital gains rates may be a good idea, if it makes sense in the context of your overall financial plan. It is important to remember that the proposed tax changes are just that — proposals, not laws. Changes can and will occur, and there is no guarantee that the proposal or introduced bills will become law. In our opinion, as of today, a wait-and-see approach is the best path until we have further clarity. However, concern about changes in estate tax law is a good reason to consult with estate attorneys to discuss the current plan. We will be ready and proactive if tax law changes occur.

From an investment portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been.

Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Sources: National Law Review, The Hill, New York Times

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Reasons for optimism as prices, bond yields rise

As we move closer to summertime, the pace of economic growth remains robust. Much of the strength of the U.S. economy can be attributed to the fiscal aid that has been injected through several rounds of stimulus. The recent boom in spending has stirred up fears of economic overheating and of potential longer-term inflation.

While prices generally have increased, metrics like the Consumer Price Index (CPI) are measured relative to the prior year, and a year ago was when the economy was broadly shut down. As seen in the chart below, the stock market (viewed by the S&P 500) reacts favorably as inflation expectations rise. In the past, sustained inflationary pressure has come from a severe tightening in the labor market. We are nowhere near a labor market crunch, as there are still millions of jobs that have not been recovered from the pandemic.

Europe’s economy finally is turning the corner, leaving its double-dip recession behind. Lockdowns, slow vaccine rollouts and delayed fiscal stimulus have hindered its recovery, but Europe is at an inflection point, and the rollout of its largest-ever stimulus plan should aid economic growth. First-quarter earnings in Europe outpaced those in the U.S. for the first time in years, another positive signal for European markets.

*EM = Emerging Markets; EPS = Earnings per Share*

The global recovery should pick up in the second half of the year as widespread vaccinations allow more economies to reopen. The demand for U.S. Treasury bonds has helped keep a lid on rising Treasury yields, which are higher than those in Japan and Europe. If global growth picks up as expected in the second half of the year, bond yields in other countries may move higher, along with U.S bond yields.

So, what can we learn from all this? Higher bond yields and inflationary pressures are not a reason to panic. Over the last 20 years, the S&P 500 has produced an average annual return of close to 6%. Optimism in the stock market remains elevated, even with the recent sell-off in the market and increased inflation concerns. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Sources: Bloomberg, Schwab, CNBC

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Why today’s inflation is different from the 1970s

We have grown accustomed to years of low inflation and lower prices for goods and services, but raw materials, semiconductors and labor now seem to be in short supply. (Anyone doing home construction knows this all too well.)

In simple terms, prices are determined by the laws of supply and demand. If demand is low and supply is high, the prices you pay for goods and services are lower. However, if demand is high and supply is low, prices will rise to meet the demand — until the supply can catch up. As the chart shows, if you have a lower quantity of goods and a higher demand for them, retailers can charge a higher price. At higher prices, buyers will begin to demand less of an economic good, and at the same time, sellers will supply more goods for additional revenue. As the supply of goods increases, prices will fall to find an equilibrium between supply and demand. When the supply of goods outpaces demand, prices drop even further.

Remember, multiple factors may affect supply and demand, causing them to increase or decrease in various ways. For example, in Texas and other parts of the country, we are seeing a housing shortage. There is a lack of supply and a strong demand for homes, as people moved to Texas from California and New York in record numbers since the pandemic began. Restaurant prices are higher as commodity prices have risen due to scarcity. Trucking companies are having a hard time attracting new drivers, so they are paying higher salaries, and cost increases are passed on down the line. These are just a few examples that are causing higher, temporary inflationary pressures.

Federal Reserve Chair Jerome Powell says the Fed expects near-term pricing pressures to diminish as supply bottlenecks are resolved and as sharp price declines from the pandemic fade from inflation calculations. The New York Fed’s recent monthly survey of consumer expectations also suggests that many expect the inflation bump to be short-lived.

In the 1970s, President Jimmy Carter took office during a period of stagflation, which occurs when there is high inflation and low economic growth. Several factors are in play today that were not happening during the high inflation of the 1970s:

* Central bank stimulus: Central banks in the ’70s reacted to high inflation by tightening the monetary supply. Today’s response is the opposite, with an increased money supply.

* Fiscal stimulus: We have seen unprecedented fiscal stimulus domestically and abroad. These programs help support business, consumer and investor confidence.

* Capital spending: Supply constraints that exist today may lead to additional capital investment by businesses, especially in semiconductor manufacturing.

* Service sector rebound: As the world economy continues to rebound from the global pandemic, and with Europe and Asia behind the U.S. in the reopen trade, the service sector’s reopening may offset manufacturing weakness.

So, what can we learn from all this? While the current environment does have some resemblance to the 1970s, the differences are probably strong enough to keep investors focused on the positives: reflation driven by solid growth accompanied with inflation, rather than higher prices with slower growth. Optimism in the stock market remains elevated, even with the recent sell-off in the market. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. In the case of potential tax on capital gains or personal tax hikes, the S&P 500 has historically performed well in years of tax increases. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Given the difficulty of timing the market, the most realistic strategy for a majority of investors is to invest and stay invested over time. Procrastination, or not investing, is worse than bad timing. We continue to view more risk being out of the market than in the market. Riding out future market volatility, in addition to having a diversified portfolio, means staying the course. From an investment perspective, we use trends to help with the strategic and tactical asset allocation and where we see the portfolio heading over the next 5-7 years with short-term adjustments along the way.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. With regards to investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: Schwab, Lucidchart, The Wall Street Journal

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Should you invest when the market is at an all-time high?

The S&P 500 has had an impressive rally since the lows of March 2020, and it already has had 27 new highs this year, outpacing the average number of all-time highs reached per year since 1988. That does not mean that the market will go up in a straight line, and it is reasonable to expect choppiness going forward because of several factors we have recently discussed: equity valuations, new COVID-19 strains and concerns over inflation.

As the market continues to hit new highs, it is likely that it also will experience a pullback. However, history suggests that now may be as good as any time to put cash to work in the market for the long run. As shown in the chart below, if you invested in the S&P 500 on any random day since the start of 1988, your one-year total return was 11.9% on average. If you invested only on days when the S&P 500 closed at all-time highs, your average one-year total return was 14.3%. The three- and five-year returns show similar results: Investing on all-time high days led to strong returns.

As we write about each week, we cannot time the market. The market fundamentals stay supportive for economic expansion, and monetary policy should remain accommodative for the next couple of years. President Biden’s first 100 days in office have seen the highest return of any president in more than 75 years, and the economy still is reopening, while almost 8 million Americans remain unemployed compared to pre-pandemic levels.

The balance in the Senate with a 50/50 split, along with a slim Democratic margin in the House, continues to provide a challenge for the White House to pass major tax legislation or policy changes. It’s possible that even if the administration changes the capital gains tax rate, some future Congress could change it back. There are several strategies investors can use to help reduce the impact from proposed tax law changes. We recommend taking a wait-and-see approach at this point, as it is unclear exactly what, if anything, the tax law would look like.

So, what can we learn from all this? Optimism in the stock market remains elevated. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance.

For those concerned about potential tax hikes, it is worth noting that the S&P 500 has performed well in years of previous increases. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Given the difficulty of timing the market, the most realistic strategy for a majority of investors is to invest and stay invested over time. Procrastination, or not investing, is worse than bad timing. We continue to view more risk being out of the market than in the market. Riding out future market volatility, in addition to having a diversified portfolio, means staying the course. From an investment perspective, we use these trends to help with the strategic and tactical asset allocation and where we see the portfolio heading over the next 5-7 years with short-term adjustments along the way.

Sources: Factset, JP Morgan

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

What would Biden’s tax increases mean for the markets?

Last week, rumors began to swirl about the Biden administration’s proposal for increasing tax rates for the richest Americans from 37% to 39.6% and raising the capital gains tax on people earning more than $1 million from 20% to 39.6%. There is still a long way to go before we see any tax hikes, and as is often the case, the initial market reaction is to sell upon hearing the news. Markets have produced better-than-average returns during past tax increases, as other economic factors are happening that may influence subsequent market behavior. Going back to 1968, there is only a minimal correlation between changes in the capital gains tax rate and market returns, as seen in the chart below.

The next chart further illustrates the point that the market selling last week on the news of potential higher tax rates may be overblown. Since 1950, only one instance of negative market returns in the S&P 500 occurred when taxes were increased. Taxes break down into three buckets: corporate, personal and capital gains. Big tax increases are rare, and only once since 1970 have all three been increased at the same time. (That happened in 1993.) Democrats have slim margins in both houses of Congress, and it is still to be determined how much of the higher tax rate agenda will make it into law. It will take time for Congress to negotiate a major package, and it’s possible that if rates are increased, it may not happen until 2022.

In years with tax increases, the average S&P 500 return since 1950 has been 9%. However, changes to the tax code do not happen in a vacuum; normally, there are other actions in Congress and the economy. As we are seeing today, significant stimulus spending by the government and action from the Federal Reserve following the pandemic shutdowns also may contribute to higher-than-average returns, even when taxes are being raised.

So, what can we learn from all this? Making market decisions based on conjecture of what might happen may be detrimental to long-term performance. The S&P 500 historically has performed well in years of tax increases. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Sources: Factset, UBS, Fidelity

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Even with inflation, the global economy’s on a roll

We have now experienced the sharpest “V-shaped” economic recovery in history — a deep global recession and rapid recovery within five quarters. A combination of vaccine rollouts and worldwide fiscal stimulus led to global growth forecast of 6% for 2021, and the U.S. GDP forecast is anywhere between 6% and 8%, which would be the fastest pace of growth since 1983.

We continue to see reacceleration in the job market, as nonfarm payrolls for the month of March grew by 916,000 jobs, and they are being added in nearly every sector, which is a strong positive for the overall economy. The downside is that we are still nearly 8.5 million jobs behind pre-pandemic levels of employment.

Inflation remains the talk of the town (and all the news channels). The consumer price index (CPI) has surged, but given that it is measured year-over-year, we are now comparing the current strong gains to depressed prices and demand from this time last year.

Inflation is rising around the world, lifted by transitory factors and supply-chain bottlenecks. With delays in ports and limited access to supply, prices are bound to rise near term. However, as shortages begin to disappear and supply delivery times shorten, inflation is expected to ease and land within a comfortable zone for world economies.

We are now in earnings season on Wall Street. Last year, we saw a surge in stock prices while earnings plunged as large pockets of the economy were shuttered. The effect of this is a growing Price-to-Earnings multiple (P/E) of the S&P 500. At the end of last year, the P/E multiple hit 27, a valuation in line with the late 1990s. With the growth in earnings in the current and previous quarters, the P/E multiple for the S&P 500 is roughly 23, which remains above average. Regardless of whether the P/E is above or below average — cheap or expensive — it is important to know that valuation based on P/E multiples is not an effective market timing tool. Markets can become expensive and stay expensive for some time without a negative impact on stock prices, especially if momentum and positive investor sentiment, like we are seeing today, are the dominant drivers.

So, what can we learn from all this? The global economy is on a roll. With strong earnings growth, increasing labor force and vaccine rollouts, all signs point toward tremendous GDP growth. Nonetheless, risks remain in the global market. Having a diversified portfolio and a mix of equities provides discipline around risk mitigation. Markets go up and down over time. The key is to stay invested and stick with the financial plan. Market downturns present opportunities to purchase stocks that were previously viewed as overvalued. In a down market, you are “buying low,” one of the fundamental tenets of investing.

Sources: Bloomberg, Federal Reserve Bank of St. Louis, Schwab

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Economic optimism — and the case for diversification

The economic outlook for the second quarter of 2021 is overwhelmingly optimistic. With stimulus checks, market performance, increasing numbers of vaccinations and even the improving weather, the optimism is real! Bolstered by an unprecedented third round of stimulus payments, consumers appear to be on a spending spree. As the economy continues to reopen around the globe, spending on goods and services is ramping up. The chart below illustrates an increase in consumer usage of credit cards at a physical location. While not quite back to pre-pandemic levels, consumers are using their credit cards at the point of sale at a rapidly rising pace.

Because stocks are a leading indicator of the economy, it typically is the case that economic data lags behind market performance. Market peaks have generally proceeded recessions, and market dips generally have preceded economic recoveries. The table below shows that in the post-WWII era, there has been only one exception to a bear market starting before a recession (2000-2002). In all other cases, the bear market started before the recession, and the bear market ended before the recession ended. It has been an extraordinary run for stocks since the short-lived COVID-19 bear market ended in March 2020.

Equity market fundamentals confirm current optimism in the market. The consensus projection for S&P 500 revenue this year is a 9% increase, and earnings per share is expected to increase by 21%. With the Federal Reserve planning to keep rates low and longer-term interest rates moving up, this has led to value stocks outperforming growth stocks to start the year. The large-cap tech stocks remain near August levels, but we are seeing a broadening out of the market leaders — another positive for the stock market. The periodic table below shows the different sectors of the S&P 500 and their monthly returns over the last year. This chart makes another case for the importance of diversification in equities.

So, what can we learn from all this? Picking the right sector or the right fund is challenging in any market — but having a diversified portfolio and mix of equities provides equity exposure in good times and bad. Markets go up and down over time. The key is to stay invested and stick with the financial plan. Market downturns present opportunities to purchase stocks that were previously viewed as overvalued. In a down market, you are “buying low,” one of the fundamental tenets of investing.

Sources: JPMorgan, Bloomberg, Schwab

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.