In June, the economy continued to improve as state and municipal governments relaxed Covid-19 restrictions and consumer activity remained strong. Consumer confidence reached 127.3, the highest level since February 2020, while retail sales (+24% from last June) remained strong and unemployment fell to 5.8 percent.
US equities continued to rise on the back of solid earnings growth, but the year-to-date trend of value stocks outperforming growth took a respite in June as interest rates fell amid predictions that the Fed would tighten monetary policy sooner than expected. The best performers were technology (+6.4%) and real estate (+4.0%).
A stronger US dollar was a drag on non-US shares, which produced marginally positive gains in local currency terms. Russia surpassed the emerging markets due to the continuous rise in oil and raw material prices, as well as the robust success of consumer discretionary e-commerce enterprises.
Hedge fund strategies produced returns comparable to traditional assets. Unsurprisingly, strategies that were long stocks did the best in a robust stock market environment. Absolute return methods outperformed traditional bond markets in fixed income throughout the month.
A slew of indicators indicate to an economic upswing that will most likely last till 2021. The tailwinds include a healthier and more confident US consumer, as well as increased government spending through the use of unspent stimulus and the infrastructure package currently being negotiated. Nonetheless, there are still dangers to the economy and financial markets associated to Covid-19, as well as relatively high equities valuations and the possibility of rising inflation and interest rates.
In terms of Covid, despite fumbling out of the gate, the United States is now among the most vaccinated countries. Nonetheless, vaccine demand has plateaued, and obtaining herd immunity appears unlikely, with polls indicating that the majority of those planning to be vaccinated have already begun the procedure. This means that for the foreseeable future, we will have to live with the virus as a manageable threat. To that aim, the Delta variety, which has begun to dominate new cases both in the United States and overseas, should be monitored, as it may impede reopening.
Investors' attention is still focused on the inflationary potential of strong growth, which is beginning to show up in the data. While inflation has recently accelerated by many measures, there are signs that the spike may be short-lived, including: (1) base effects, in which prices are up but only relative to the Covid-induced lockdown period; (2) shortages in goods and materials, which are partly due to changes in global supply chains, are slowly being resolved; and (3) US worker shortages may be resolved by year's end as more people take new jobs or return to old ones.
At this stage, inflation may remain elevated while these factors fade, and we will keep an eye out for indicators of a long-term, problematic rise in prices. Interest rates in the United States are also likely to rise, as the Federal Reserve has expressed a bit greater urgency in controlling inflation and plans to trim the billions of dollars in monthly asset purchases.
We continue to search for ways to diversify our portfolio and mitigate potential risks, such as tax increases and inflation. On the latter, we want to find some inflation protection while also looking for appealing risk-reward prospects. We believe we have that combination, which includes our holdings in infrastructure equities, which should provide a hedge against inflation and are now trading at very low valuations.
Fixed income may become less effective as a diversifier when the price correlation between equities and bonds rises. In reality, low interest rates are one of the reasons behind equities' current high valuations. This means that bonds may not provide as much downside protection as in the past in the event of a market slump caused by rising interest rates. Fixed income will almost certainly continue to provide needed diversification, but alternative income-producing assets may be necessary to keep portfolios in line with risk and return objectives.