Risk assets finish off  the first half of 2021 in style 

With earnings season yet to kick off, all eyes have been on the jobs picture recently, and investors haven’t been disappointed. For the month of June, the Bureau of Labor reported that payrolls grew faster than expected for the first time in months, topping 850,000 (expectations were for 675,000). Further, initial jobless claims during the last week of the month came in at a pandemic low – 364,000 – well below the 400,000 that economists expected, according to FactSet.

But with an acceleration in retirements and hesitancy among many to return to work, the participation rate was anchored at just under 62%. Additionally, there are still over 6.5 million fewer jobs than when the pandemic began, and continuing jobless claims, including all emergency programs, exceed 14.6 million. There is work to be done for workers who aren’t yet done.

Even with a steady inflow of solid jobs data, the bond market’s takeaway has been that the employment picture won’t alter the Fed’s course anytime soon, demonstrated by the decline in rates. The yield on the 10-year fell from 1.54% to 1.45% over the three days following the payroll report, and continued that downward trajectory into July, with the 10-year yield reaching 1.3% as of the time of this writing (7/8/21).

With bond markets becoming more sanguine about the inflation picture and the decreasing likelihood of premature tightening, corporate America continues to take advantage of the wide-open credit spigot. According to BMO Global Management, investment grade issuance in June finished at $113 billion, in line with expectations. And in the high yield market, $38 billion was priced, taking the first-half’s sales total to a record $282 billion. BMO added, “With spreads tight and all-in yields near historic lows, many are expecting the summer new issue calendar to remain busy.”

Corporations could hardly ask for better liquidity conditions, but for those most adept at lowering their tax bills, new concerns may be arising. In the coming weeks, investors will be casting their collective gaze toward the Capitol, trying to assess the likelihood of Congressional approval for the global minimum corporate tax rate for which Treasury Secretary Janet Yellen recently secured international backing from a group of about 130 countries. The plan is meant to curtail tax avoidance maneuvers, and the number that is being targeted is 15%. Lawmakers and business groups will now need to assess the likelihood of other countries actually following suit if in fact the U.S. does move ahead with the plan.

What happened in the markets in June?

1. Equities: Paging Pollyanna

Equities were mixed for the month, with the large cap growth darlings racing ahead by 6.3% (Russell 1000 Growth), while value stocks (Russell 1000 Value) falling by 1.2%. In fact, the Wall Street Journal reported last week that over the 170 trading days since the market last experienced a 5% correction, growth and value stocks have essentially acted independently, with the correlation between the two falling under 0.25 (data provided by Refinitiv).

Similarly disparate performance between growth and value was observed in the small cap space and in international developed equities for the month, with the worst equity segment, international small value stocks, ending 2.8% lower (MSCI EAFE Small Cap Value). Of course, the advancing U.S. dollar had something to do with the performance of international developed and emerging market equities; the MSCI EAFE Index, fully hedged, put up a respectable 1.4% for the month, but translated back to dollars, was down 1.1%.

Speaking of equities, a recent survey by Natixis[1] shows the increasing gap between what financial advisors believe that global equities can return over the long-term and what investors believe. The former group thinks that 6.7% real is reasonable, while the latter…drum roll please…deems 17.5% real, possible. Yes, 17.5% after inflation. Financial advisors will have their work cut out for them trying to reign in those expectations, and may have already lost the initiative—BofA Global Investments recently reported that equity inflows for the first half of the year, would, if equaled in the second half, exceed total equity inflows for the prior 20 years on a cumulative basis. Not a day goes by anymore when we aren’t shocked by some gauge of investor enthusiasm for this market.

2. Bonds: Plummeting Yields Have Investors Nonplussed

With the yield on the 10-year recently hitting 1.3% despite rosy economic data, and well below the 1.74% high reached at the end of the first quarter, many market participants are scratching their heads a bit, but they’ll gladly count their returns. For the month of June, bonds performed quite well, with the Bloomberg Barclays U.S. Aggregate Bond Index gaining 0.7% and both duration and credit paying off. Long-term Treasuries posted a return of 3.8% (Bloomberg Barclays U.S. Treasury 20+ Yr) and high-yield corporates (Bloomberg Barclays U.S. High Yield Corporate Index) advanced by 1.3%. Investment grade corporates (Bloomberg Barclays U.S. Corporate Index) did a bit better, returning 1.6%.

3. Commodities: Divergence

As a group, commodities generated solid gains, with the Bloomberg Commodity Index advancing by 1.9%, but under the surface things looked a bit different. After a series of months when all things grown, raised or mined headed north, investors were a bit more discerning in June. About half of the sub-components of the Bloomberg Commodity Index were in positive territory, while the rest fell. Energy related bets paid off, with natural gas (+21%) and WTI crude (+11%) leading the way. On the other hand, industrial and precious metals fell out of favor; platinum futures were down 9.6%, copper futures declined by 8.4%, and gold fell about 7%.

How are Frontier strategies positioned?

Allocation Changes

During the month of June, our strategies generally saw modest increases to their target allocations to U.S. large-cap equities and high-quality bonds by reducing allocations to U.S. small-cap equities and long-term Treasuries. However, relative to our long-term allocations, we remain underweight REITs, high-yield bonds, absolute return, and U.S. large-caps; and are overweight long-term Treasuries, managed futures, and U.S. small-caps.

Performance Attribution

All our strategies posted positive returns for the month of June, gross of advisory fees, adding to what have been solid returns for the first half of the year, given the risk that investors needed to assume to generate such returns. Admittedly, our overweights to small caps (and the quality bias within) and emerging markets, as well as our underweights to U.S. large cap stocks and REITs left the majority of our strategies trailing benchmarks for the month. Further, some of our active fixed income managers hurt relative performance, as many have kept duration quite low, and as noted, long dated bonds greatly outperformed expectations. Lastly, our overweight to managed futures, which had been nicely additive for much of the first half, negatively contributed to both absolute and relative performance for the month.

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[1] “2021 Global Survey of Individual Investors: The Next Normal”, Natixis