Q2 2021: Follow the Data, Not the News

Executive Summary

You already know how important it is to us at Gatewood Wealth Solutions to serve as a trusted source of financial information on all things market- and economy-related. We want to signal through the noise to help you understand what's worth paying attention to and what's just media hype. But that's no easy task when you're finding yourself constantly bombarded with fear-inducing headlines and social media threads.


Recently, we heard one economist share that his mantra is, "Follow the data, not the news." Of course, that resonated with us immediately, as it's precisely what we strive to bring to our GWS clients and Weekly Market Insights listeners. The reality is that if you follow the news, it's easy to become very fearful. Think about it — the news is in the business of selling advertisements. And one of the best ways to get you to sit through a commercial or an ad is to scare you just enough to listen. But, on the other hand, if you look at data, you gain a better sense of what's happening in the market and make informed decisions based on those insights.


Speaking of digging into the data to find actionable insights, let's dive into our key themes from Q2 of this year: inflation expectations, value/growth rotation, housing market boom, and supply chain blockages. We'll start by looking at the market's behavior as we wrap up this quarter.


Wrapping Up Q2 on a High

As of this writing, today is the last day of the month, and it looks like we're going to end in a gain position with the market. This will be the fifth month this year so far. But are we at the top?


No one rings a bell when market performance peaks, so there's no way to be sure. But we are following some fairly pervasive patterns. For example, take a look at the graph below, which shows the seasonality of the market.

Percentage of Months in Which $SPX Closed Higher than it Opened from 2012 to 2021

As you can see, the chart above looks back over the last ten years at each month. We see how often the S&P is higher from when it began. A few observations:

  • January has been up 50% of the time over the last ten years.

  • If we frame April, May, and June as a quarter, that's the best quarter based on seasonality.

  • July is up significantly; 89% of the time, the S&P has been positive for July.

  • Going back further, September and October are the months with the highest likelihood of a correction.

You might ask, "If we're entering into July, will that impact the decisions we make since it tends to be a higher month — and then there's a higher chance the market will be down?"


The answer is no because most of the time, in this scenario, we still have positive months. Fifty-six percent of the time over the last ten years, the S&P continued to move up and into positive territory during this period. This is known as technical analysis. We think there are economic reasons that corrections happen in October, but this doesn't tell us if we're due for one or not.


Next, let's look at the volatility of the market. What's the likelihood of a correction coming up?

$VIX Volatility Index - New Methodology INDX June 2021

Let's start by considering the Volatility Index (VIX)— or what many people call the fear index. This measures options: calls and puts. What are calls and puts? A call option gives someone the right to buy a stock, and a put option gives them the right to sell it. A call is essentially a down payment for a future purchase.


As an example, let's say Aaron owns AT&T when it is trading at $50. If he sells it to John at $55, and John pays $2 for the right to repurchase it at $55, John might repurchase it when the stock moves up to $60. The longer the option lasts, the more valuable it is.


Since April of 2020, the VIX has been trending down. However, the options in the market are trending in a way that doesn't suggest a high probability of a correction at the moment. (Watch our Weekly Market Insights recap video for a full explanation of how we measure volatility.)


Theme 1: The Value/Growth Rotation

This quarter's value/growth rotation has been somewhat of a teeter-totter: volatile on the edges but a calm constant in the middle.


For example, consider the graphs below showing how much the market was plus or minus 1% on a given date. Thus, 2021 looks somewhat average in terms of volatility, which might seem strange. But, there's more to the story.

NASDAQ DORSEY WRIGHT - Number of 1H +/- 1% Days and Number of 1H +/- 2% Days, Data from S&P 500 Index, 4/30/1987 through 6/25/2021

Now, let's look at the edge of the teeter-totter: the ongoing value/growth rotation roller coaster. In the graphs below, we separate growth and value and look at how much they were plus or minus 1% on a given date. Again, you can see the charts look far more volatile.

ASDAQ DORSEY WRIGHT - Number of 1H +/- 1% Days for RPV and Number of 1H +/- 2% Days for RPV, Data from Invest S&P 500 Value Portfolio 7/3/1995 through 6/25/2021

For most of the year, especially the first part of the quarter, we've seen a value rotation in the market. As a result, we've made relevant changes to our portfolios, balancing those changes, of course, with tax impacts.


Theme 2: Inflation

Talk earlier this year of an additional $6 trillion in stimulus money sparked many discussions on inflation expectations. Now that those stimulus numbers have been reduced – and we see deflationary forces from technology and other areas – we don't view inflation risk as high as it previously was. So we may see a bit of a reprieve on inflation going forward, which may also be the reason for the growth rotation mentioned above.


The Biden administration has the difficult task of making Manchin and Sinema happy while also trying to appease more centrist republicans like Romney when going after the filibuster. Currently, we believe the filibuster is too far away from markets and into politics for us to comment on.


Theme 3: Housing Market Boom

As the housing market continues to add fuel to its fire, many people have flashbacks in their minds to 2008 and wonder if another housing bubble is forming. The short answer is yes, it is developing — but it won't pop now. There are four key reasons why:


  1. First, inventory is the lowest it's been in 20 years.

  2. The stimulus bills increased liquidity. As a result, default rates are low, and the number of customers at risk of becoming delinquent is down 90%.

  3. Bank lending requirements have changed since the aftermath of the 2008 financial bubble. The practices are much stricter, so it's less likely to get out of control.

  4. Millennials are aging and advancing their careers — so the demand for housing won't abate any time soon.

Theme 4: Supply Chain Bottlenecks

Avid listeners of our Weekly Market Insights will recognize supply chain bottlenecks as a common topic over the last quarter. However, we are finally starting to see supply chains open up again, although there is still a significant shortage of truck drivers.


We had expected to see a declining dollar to reduce imports and increase exports — but that hasn't happened yet. This is likely because consumers have shifted their expenditures to imports since the service economy was shut down.


For example, if they couldn't go to dinner, a couple might have spent that $80 on clothing or another consumer good instead (products that are more likely to be manufactured in other countries; thus, imports). This increase the demand for shipping coming into American ports, but more miniature goods were leaving. This was causing issues in distribution and logistics. Especially for shipping containers, they arrived in the US but did not leave, meaning a global shortage in containers.


Now that the service sector is recovering, it will be interesting to keep an eye on the effect on imports, exports, and the dollar's value.


Looking Forward

Looking outward at the rest of the year, we believe we are starting to see growth reassert itself.


We were concerned that if we didn't break through this dome, we would start to dip. I'm happy to say the market wanted to go through that tactical dome, and there was more demand for stock positions (people seeking to buy) than the supply of stocks (people selling at current prices). Hence, stocks moved up at price because there is always an equal number of buyers as sellers.

$SPX S&P 500 Large Cap Index INDX - Price Points for Dollar Cost Averaging

What's happening in the market has consolidated and is taking a breather. The longer it's taking the break and trying to decide if it's going to upside or downside, the greater the movement will be when it happens. So, we're reading tea leaves here, but based on technical analysis, this tends to be a good indicator of how much price upside and downside risk we have.


Conclusion

When we start to think about the risk on the upside vs. downside, it's a pretty favorable market at this point. Of course, there could always be a black swan event. But from a technician's standpoint, we're looking at a pretty decent risk/reward ratio when looking at the technical.


As we said, we're following the data.


Speaking of data — we're committed to bringing you our interpretation of market data every Wednesday on YouTube Live during our Weekly Market Insights broadcasts at 3:30 p.m. CT.


Be sure to subscribe to our YouTube channel and tune in each week to hear how we adapt clients' portfolios and our investment thesis for the upcoming investment horizon. We're here to help you make sure you're doing the right things to preserve your wealth, which is part of our mission to help people become and remain financially self-reliant.


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Disclosures

Securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.


The opinions expressed are those of John Gatewood as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended to endorse any specific investment or security.


Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. With fixed income securities and bonds, when interest rates rise, bond prices usually fall because an investor may earn a higher yield with another bond. Moreover, the longer the maturity of a bond the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. High-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk.


Investors should be aware of the risks of investments in foreign securities, particularly investments in securities of companies in developing nations. These include the risks of currency fluctuation of political and economic instability and of less well-developed government supervision and regulation of business and industry practices, as well as differences in accounting standards.



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